Banks Cosmetic in Cutting Lending Rates
By Kim Jae-kyoung
Staff Reporter
The central bank surprised the market Thursday by slashing its key rate by a record one percentage point to a historic low of 3 percent, but borrowers have shown frustration over the lukewarm attitude shown by banks in lowering lending rates.
Since October, the central bank has slashed its rate by a total of 2.25 percentage points, but bank lending rates backed by collateral have fallen by only 72 basis points to 7.64 percent. For loans without collateral, the rate runs as high as 9-10 percent.
Bank of Korea (BOK) Governor Lee Sung-tae criticized the banks for their ``cosmetic'' reductions in lending rates following the series of cuts in the central bank's key rate. He said that deposit and lending rates should go down in proportion to the key rate.
Market rates have not fallen in tandem with the base rate cuts due to a tight liquidity. But the Thursday reduction is expected to push down market rates, including yields on certificate of deposits (CDs), providing more leeway for banks to cut rates. The yield on three-month CD is the benchmark for banks' lending rates.
The market welcomed the record rate cut. Yields on three-year and five-year treasury bills fell by 20 basis points and 8 basis points, respectively, to 4.01 percent and 4.44 percent Thursday.
``We expect a reduction of the CD rate, which has been stuck at 5.44 percent since the BOK cut by 25 basis points,'' ING Group economist Tim Condon told The Korea Times.
``We expect it to fall by 75 basis points to around 4.75 percent in a month. The three-month treasury bill yield was already slashed by 50 basis points and we expect another 50 basis-point cut,'' he added. The three-month CD rate dipped by 69 basis points to 4.75 percent Thursday.
Analysts said that given the rising risks of recession, the central bank will remain in its credit easing mode.
``We welcome the central bank's frontloading of rate cuts. It is a sign that the economy is deteriorating much faster than expected,'' Morgan Stanley Asia chief economist Sharon Lam said.
``We now expect another 200 basis point cut to bring the base rate down to 1 percent before June in 2009,'' she added.
Goldman Sachs Korea economist Kwon Goo-hoon echoed the view, forecasting that the BOK will continue with the proactive easing, with further cuts of 50 basis points by next March.
``We believe the central bank's more active open market operations, including direct purchases of CDs and debentures, are necessary and will also help address liquidity shortages,'' he said.
The Thursday cut, the most aggressive in the central bank' history, came as Asia's fourth largest economy heads downward at an unexpectedly fast pace in line with the deepening liquidity crunch.
The surprise move is aimed at minimizing the economic downturn and easing the liquidity shortage. Easing inflationary pressure provided more room for the aggressive rate cut.
At a meeting with reporters following the monetary policy meeting, BOK Governor Lee highlighted the growing scale of the economic slowdown, saying, ``The economy is careening on the edge of an emergency situation or severe credit contraction.
``We are now in a situation where we have to decide whether to stick to traditional tools or deploy unconventional tools. We are considering offering liquidity to specific financial sectors if they are suffering from cash shortages.''
``Growth will slow sharply for a considerable period of time. Domestic consumption and investment have been contracting, while export growth has turned negative,'' he added.
The top central banker left the door open for further rate cuts in the months to come, saying, ``The possibility (of more rate cuts) is always open.''
The ball is now in local lenders' court. In order for the rate move to affect the economy and make more credit available to struggling firms, banks should play their role as a source of capital for the economy.
However, banks have been contracting their balance sheets in their own self-interest for survival and stopped functioning as a money supplier, which broke the monetary policy transmission mechanism and deepened the liquidity crunch here.