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TREASURY VIEW

Interest rate heading back to reality

By Parson Singha

On July 14, the Bank of Thailand raised its policy interest rate by 0.25 per cent, the first move in more than fifteen months.

The decision surprised no one. Since the beginning of the year senior officials at the central bank have been saying that local rates are too low. They stepped up such comments over the past month as Thai economic data improved.

The policy rate had been cut drastically in early 2009 amidst the worst global financial crisis in 70 years. However, that crisis has dissipated and the world economy, while remaining weak, has recovered significantly.

The policy rate is the foundation that impacts other interest rates in the financial system, such as bank deposit rates and bond yields.

The Bank of Thailand is keen to avoid the impression that it is tightening monetary policy, or trying to slow down economic growth. It calls this policy a "normalisation" of interest rates.

This begs the question, what is the normal interest rate?

Not surprisingly, there is no clear answer (no, it is not 42).

The appropriate level of interest rates depends on many factors - such as inflation, economic growth and the output gap.

One simple methodology (drawing on the Asian Development Bank) is to estimate a normal rate using the long-term average real policy rate (adjusting for inflation). In Thailand, this figure is around -0.1 per cent. Given inflation of 3.4 per cent, this implies that the current rate of 1.5 per cent is still 1.8 per cent below normal.

There are still risks to growth, and rate normalisation is likely to be gradual. Recent surveys show that analyst consensus is for a policy rate of 2.5 per cent by the middle of 2011, or a further rise of 1 per cent. Bond yields are also pricing in gradual hikes, with the one-year benchmark quoted at 1.91 per cent and the two-year at 2.45 per cent.

Parson Singha is chief markets strategist in the Global Markets Department of HSBC Thailand.

-- The Nation 2010-08-03

[mortenaa]

Why is there such a huge gap between loan rates and interest rates on deposits. Seems to me that Thai banks are having much higher margins than banks in Europe. Am i right?

[12DrinkMore]

Why is there such a huge gap between loan rates and interest rates on deposits. Seems to me that Thai banks are having much higher margins than banks in Europe. Am i right?

The banks do not operate on the margin between the loan and deposit rates.

They use the universal system of "fractional reserve banking", allowing them to lend a multiple of the depositor base. This multiple is often 10 or more.

So along you come and deposit say 1,000,000 Baht. This money is then, contrary to popular opinion, no longer "yours", but it belongs to the bank. You are merely just another creditor. The bank pays you say 1% for the use of your money. So you receive 10,000 Baht after twelve months. However the banking system (gets a bit complicated, but the end result is the same) is then able to lend out 10,000,000 Baht at say 6%, making 600,000 Baht each year.

Sorry if you knew this before, but the vast majority of the peeps in Farangland and I expect almost the entire population of Thailand do not have a clue about how this works. I certainly didn't until this financial crisis came along and caused me a certain amount of financial pain.

This is why I hate the banks, they are basically a massive scam.

[quiksilva]

I thought they did both. Yes they use the fractional reserve system but they also profit on the spread between deposit and loan rates.

As I understand it they claim they need to have this large spread because other banking services are not as profitable or are in less demand in markets like Thailand.

[AnnyLing]

So along you come and deposit say 1,000,000 Baht. This money is then, contrary to popular opinion, no longer "yours", but it belongs to the bank. You are merely just another creditor. The bank pays you say 1% for the use of your money. So you receive 10,000 Baht after twelve months. However the banking system (gets a bit complicated, but the end result is the same) is then able to lend out 10,000,000 Baht at say 6%, making 600,000 Baht each year.

And the ridiculos myth goes on.