September 2009 Monetary Policy Update

Banks have begun to raise their lending rates on home loans and other financing – is this justified? From a consumer perspective this is a blow against disposable income, albeit a rather small one (for the moment). But from the banks’ perspective, the rate hike has been probably overdue. The Base Lending Rate (BLR) is supposedly the rate at which banks would lend to their best customers, and essentially provides enough of a margin over their cost of funds (COF) to cover loan defaults, overhead, and reserve requirements. But stiff competition in the banking sector has rendered BLR irrelevant as the benchmark lending rate:




Average lending rates have been consistently below BLR since 2004, and below 3% above overnight money since early 2007:



With prospects of economic recovery now clearer and loan demand sustained, there’s a feeling that interest margins have been overly compressed and banks are mispricing default risks. I have some sympathy for this view – when it comes to loan supply, it’s probably a little better to err on the higher side for pricing. If there is one lesson that we’ve learned from this past crisis, it’s that it’s all too easy to misjudge risk in the financial sector, more so since we have an environment of very low loan defaults and high domestic liquidity. But for those reasons, I don’t expect too much in terms of rate hikes in the next couple of months though – really about 20-30bp, 50bp on the outside.

Speaking of liquidity, there’s been slight movement on the monetary front (log annual changes):



I expect monetary growth to fall back in October-November, but to pick up later in December.

There’s not a whole lot of movement on the interest rate front either. BNM has kept the OPR at 2.00%, and the government only borrowed in September to redeem RM4 billion in MGS that had come due. MGS yields as a result stayed pat:



RM2 bilion in Khazanah bond redemptions also partially offset a year high RM4.5 billion in PDS issuance, so bond supply only marginally expanded.

The only big movement on the monetary front has been the Ringgit, but that's largely a US dollar story and not a Ringgit story, so I'll leave that for another blog post.