[SERI COLUMN]Growing rates, slowing economy don’t mixInterest rates on certificates of deposit are at their highest level since 2001, as banks try to compensate for savings accounts that are steadily getting depleted. Since those rates are linked to the lending rates of households and businesses, it is squeezing borrowers.
Is there relief in sight? Yes and no.
In pursuit of higher returns, there has been a massive shift of savings money to equity funds and high-yielding cash management accounts, or CMAs, in brokerages. The Kospi has soared more than 40 percent this year, giving new investors confidence. Meanwhile, brokerages positioning themselves for the “big bang” deregulation of the financial industry in 2009 have been heavily marketing those CMAs as one-stop accounts for investing and saving.
As a result, the total amount of bank deposits fell on average each month 1.84 trillion won ($1.98 billion) from January through September. During that time, the monthly amount, on average, going into equity funds and CMAs was 5.1 trillion won and 1.58 trillion won, respectively.
To raise money, banks have turned to costly CD and bond issuances to lure back savers and fund more business loans, which generate interest income for the banks.
Between January and November, banks issued CDs worth an average of 2.57 trillion won per month while issuing bonds worth 2.64 trillion won. Meanwhile, bank loans rose by 7.47 trillion won on average each month between January and November.
The flood of CDs and bonds, of course, has raised the overall supply. That’s where the trouble looms. Banks are also a major institutional investor in bonds, but they now have less capacity to do so because CDs and bank-issued bonds are expensive sources of funding. This has led to a narrow gap between short-term and long-term interest rates (i.e. CD rates and government bond yields), which in turn has pushed up long-term rates and raised overall interest rates.
The November rate on CDs rose to 5.5 percent, compared to 4.9 percent at the beginning of the year. That means the CD rate is higher than the national economic growth rate. It also raises the linked loan rate to businesses. With big corporations flushed with cash, banks have focused their lending on small- and medium-sized enterprises. If the rising lending rate stifles such enterprises, vital corporate investment needed to sustain economic recovery will be denied.
The issue at hand is whether the trend of rising CD rates will continue. In the short term, CD rates are likely to slow their upward march next month because of short-term supply and demand. Banks issued a flood of 91-day CDs in May and August. When the ones issued in August matured in November, banks again issued CDs to cover their payments. In September, however, the amount of CD issuance was relatively modest, suggesting the supply in December will not be as dramatic. Consequently, CD rates are expected to drop in December.
Over the long term, however, the outlook is more complicated. Surely inflows into equity funds could sputter if the stock market cools, but the overall trend suggests a move from low-yielding savings accounts to equities well into the future.
Banks will thus be pressured to expand their special sales of higher-yielding deposits or decrease lending. Such measures, however, won’t last because special sales have a short life, causing inflows to slow once more. Reducing loans, on the other hand, threatens the fundamental purpose of a bank’s mission, making this a difficult choice. At least for now, banks are expected to continue to depend heavily on bonds and CDs for revenue.
What is the overall outlook for interest rates? The present interest rate levels do not adequately reflect economic conditions, because the economy has not expanded as much as interest rates have risen. Moreover, interest rates in Korea are not in line with the global trend. Although we cannot accurately forecast how long this decoupling will persist, downward pressure on interest rates in the global markets is certain.
A change in market conditions, action by Korea’s monetary authorities to constrain lending and movements in the international financial markets could all put downward pressure on the local rates. In light of these conditions, interest rates will likely continue to rise, at least for the time being.
Eventually, however, high rates will need to be backed by the real economy to continue. Given that the current rate level is sustained by the demand-supply factor, it will change course when affected by external conditions.
*The writer is a research fellow at Samsung Economic Research Institute. Inquiries on this article should be addressed to email@example.com.
BY Jeon Hyo-chan