The Interest Rate problem is an Inflation problem

The raging brouhaha between the Bank of Ghana (BoG) and the Commercial Banks regarding lending rates has degenerated into a blame game. While the BoG is faulting the Banks for not reducing lending rates to support the Central Bank’s prime rate reduction, banks are blaming the BoG for high reserve requirements and tight money supply policy. Banks also claim that the economic environment is generally risky and savvy investors are demanding better returns for their money.

In February, the Central Bank cut its policy rate from 18% to 16%. The average bank lending rates are currently around 28%.

The reserve requirements (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. In Ghana it is held at the Central bank and is currently 9% of all deposits. The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's economy, borrowing, and interest rates. If a bank is risk averse it holds reserves in excess of the required amount. So technically, Ghana banks have 91% of their deposit base to on-lend.

The effect on money supply is quantifiable. Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 9%, for example, a bank that receives a Ghc100 deposit may lend out GHc91 of that deposit. If the borrower then writes a check to someone who deposits the GHc91, the bank receiving that deposit can lend out GHc83. As the process continues, the banking system can expand the change in excess reserves of GHc91 into a maximum of $1,011 of money i.e. GHc100/0.09=$1,011. In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial GHc100 deposit into a maximum of GHc500 i.e. GHc100/0.20=GHc500. Thus, higher reserve requirements reduce artificial money creation and help maintain the purchasing power of the currency in use. Banks’ logic is that the reserve money at the Central Bank is tying down deposits and not earning any interest. The BoG says no, reserve requirements are at their lowest ever, the country’s risk portfolio is at the best in it’s history, and borrowing needs are at the highest, therefore competition should be driving interest rates down. This clearly is not happening and the frustration is building up on both sides.

The fact is the banks have a cushy ride. The margin spread is too good to resist, with one year treasury notes paying 16% (March 22, Daily Graphic, p14). Deposits are medium to long term and a 91day turn around can net 7% to 9% with no effort. Standard Chartered Bank pays 8.13% to depositors and lends out at 29.5%. No one looks a gift horse in the mouth.

But with inflation currently at 14%, banks argue that they cannot make a real return if they reduce interest rates any further.

Obtaining credit in most developing countries is a frustrating process that usually leads to wrong credit decision-making. Banks are therefore unwilling to extend credit without assurances that borrowers are creditworthy and that it will be possible for them to pay back.

The government signed into law the Credit Reporting Act, 2007 (Act 726) on April 13, 2007 to facilitate the activities of reference bureaus. It took 6 months for the Act to become law and a further 12 months for the Bank of Ghana to start implementing the law.

The law is meant to support the banks in making good loans and help to reduce risk and minimize the bad debt situation, which nearly doubled from 7.6% last year. Even though section 25 of the Act provides that Financial Institutions (FI’s) shall report to the licensed credit bureau, information without the consent of the borrower or customer, the FI's can only do so for loans 90 days after the repayment date. This implies that during the pendency of the loan, FI’s cannot pass on the information for use by another bank where the borrower intends to engage in multiple loans. Similarly if after the 90 days the FI intends to give the information out they have to give the borrower 28 days notice.

Section 26 of the Act, refers to situations where consent must be required at the time of opening accounts or filing a loan application form or entering into an agreement with the borrower. If the borrower says no at this stage the FI cannot give the information to the Credit Bureau without their consent. The consent has to be in writing.

The effect of the two provisions clearly shows the unwillingness to disclose. BoG is not required to compel FIs to provide credit information and therefore very reluctant in empowering the FIs from doing so.

The Central bank is not enforcing this law and the banks are not in any hurry to provide the required information to the credit agency. The Banks are calling the Bog’s bluff. We have 2 years to fix this problem and to bring down costs. 2012 is an election year and our politicians cannot resist the spending spree in that year. Every election year, our macro economy goes haywire, whether it is NDC or NPP, CPP or Great CPP. Voters are treated to political largesse at the expense of economic stability (read CEPAs “A tale of two cities” in the March issue of Business in Ghana”.) and this leads to an inflation hike for the next government to fumble with.

So far, inflation is coming down, but the BoG does not have a ready answer, neither does it have a magic wand to wave at the micro economy where it has to be felt by Nana, Kofi and Maame.