Tue, 20 Jun 2017 13:37:52 +0000
By kelvin Chungu
The Kwacha has been stable for close to a year, while the Inflation rate has reduced to 6.5% at the end of May 2017 from 7.5% at the end of December 2016. The relative macroeconomic stability that has been attained this year calls for broad consideration of the level of lending rates charged by commercial banks, if we are to see tangible growth from our productive sectors in Zambia.
In March 2017, I wrote about the reasons for the prevalent high lending rate regime charged by the commercial banks in Zambia relative to the lending rates obtaining in neighbouring countries of about 7.5% to 12%. Subsequently, the Bank of Zambia in its May 2017 policy statement, reduced its monetary policy rate to 12.5% from 14% and the statutory reserve ratio from 15.5% to 12.5% in a move aimed at allowing more liquidity in the economy to enable Banks to have an improved pool of funds to lend from.
This move was anticipated to signal the significant reduction in lending rates, at least even mildly to the 2014 levels, throughout the financial sector, however the policy actions have not found equal and meaningful reduction in lending rates to the private sector by the commercial bank.
Added to that, the interbank rate has reduced by 59% compared to the previous year to rally around an average of 11%. The interbank rate is the rate banks use for financial transactions among themselves and are not normally publicly observable.
And so the central question has been, ‘why is the reduction in policy rates, including interbank rates not been reflected in the lending rates that are being charged by commercial banks? One argument could be that the policy rate has been ineffective in signalling the level of acceptable lending rates and this is an indication that the degree of competition in the financial sector remains abysmally low.
To understand the size of margins that the commercial banks in Zambia are on average making, we need to consider the main factors influencing the lending rates as follows:
- Bank of Zambia Policy rate, which is now at 12.5%
- The risk free interest rates implied by short-term government securities yield rates at 12.5%
- Inflation rate at 6.5%; and the
- Negotiated Deposit rates, which are on average at about 11%.
When we reflect that the medium term inflation forecast by the Bank of Zambia is that it will remain within 6% to 8%, this translates into a real monetary policy rate forecast of 4.5% to 6% (12.5% – 6.5% or 8%). That is assuming the actual monetary policy rate remains at 12.5% in the medium term and when we consider that, the overnight lending rates (OLR) and the overnight Interbank rates (OIR) are now at 18.5% and at 11% respectively, there is no justifications for the current levels of lending rates.
Let’s put it in perspective, a commercial bank that borrows at an OLR of 18.5% from Bank of Zambia and adds a margin equivalent to the inflation rate of 6.5% can get to a lending rate of 25%, which margin is 0% in real terms at current inflation levels. Similarly, where the commercial banks relies on negotiated deposits currently at an average of 11% for its main source of funds, it can charge 18.5% in lending rates, assuming a margin of 1% above the inflation rate. This would still be above the rates charged by the banks in the region that are charging average negative real rates of about 2%.
In practice however, banks generate funds from multiple sources including its own capital whose return when benchmarked against the reserve ratio of 12.5%, implies at a minimum an 18.5% lending rate at 0% return in real terms. Real returns, in this case are defined as lending rates less the current levels of inflation.
In contrast, the average Commercial bank lending rate are currently at about an average of 29% – 34%, which is about 11% decrease from what was obtaining in December 2016, when the policy rate reduction was about 20%.
If we define the assumed cost of funds as the sum total of inflation rate currently at 6.5% at the end of May 2017, and the policy rate currently at 12.5%, we get to an assumed cost of funds of 19%. In this scenario, the margin between the assumed cost of funds (ACOF) to the average commercial bank lending rate of 29% is 52%, when the average lending rates in the region offers a starkly different picture as follows;
In this analysis, we can see that Botswana lending rate is at a negative real rate of 11.77% below the assumed cost of funds, Namibia at negative 11.65%, South Africa at negative 12.86% and negative 17.75% for Zimbabwe.
When the Zambian market risk is considered, it is tricky to assert that the higher mark-up that Zambian banks offer, accounts for risks not present in the neighbouring countries noted above.
If we assume that, the policy rate signals the cost of funds in each of the above countries, then the above analysis shows that it is not unreasonable to theorise that the local lending interest rates reflect a super profit mark-up over foreign ones. This is more so that the examples cited above are of countries in the region with similar inflation levels and market risk.
The general problem has been that it appears that banks in Zambia are unwilling to do the business of banking, partly because the high yields on government securities have historically provided an easier platform for banks to substitute for its expected normal operations.
It is also notable that the government financing demands in the recent past to bridge the budget deficit have led to higher auctions of government securities at significant yield, therefore crowding out the private sector by pushing private sector lending higher. However, since December 2016, there has been a notable decline in the yields on government securities signifying a lower appetite by government to increase its open market operations (OMO).
The decline in OMO activities and the Central Bank by its monetary policy statement have been signalling banks to reduce their lending rates, however it is not yet clear that the monetary policy alone is an effective mechanism in Zambia to signal the commercial bank’s lending rates.
It is therefore tempting to suggest that the Central bank must introduce the capping of interest rate, however this would ultimately lead to the reduction in the availability of aggregate credit in the medium term as banks would apply their funds elsewhere.
Therefore the removal of the interest rate caps in 2014, remains a good policy to improve the aggregate credit availability. At the same time, it is clear that this policy has not yielded the right responses from commercial banks and therefore this article is advocating for other players to play their part to compel commercial banks to reduce their rates. In this vain, there is a role for the Competition Commission to review the pricing structure in this sector, in addition to other voices such as the chambers of commerce beginning to increase their advocacy for lower lending rates.
The continued prevalence of high cost of credit make the monetary policy choices made by the Bank of Zambia to be relatively academic in terms of influencing the target inflation levels in the long run, given that high interest rates inhibit economic growth and which ultimately causes inflation to rise. And the cycle continues with no end in sight.
It is also important to acknowledge that the commercial banks high operational costs, including the high costs of managing many small deposits and borrowers with insufficient credit references are also grounds for this rigidity, however, much of the bank’s overall cost are self-created.
This is the analysis that needs to be regularly and repeatedly explained, however, none of this can be properly voiced and often, unless our various Chambers of Commerce took their rightful role in advocating for lower lending rates in the country.
There are lessons to learn from the mining chamber’s effectiveness in advancing its message and delivering results for its members. How has it been able to do it?
The mining chamber manages to get results because they are clear about what needs to be in place to enable the productive cost-effectiveness of their members. They are visible and regular.
In Kenya, Ghana, and other countries in Africa, the voice of the chambers have been visible in urging commercial banks in their respective countries to moderate their interest rates to enable the private sector access affordable loans. This has not been the case in Zambia.
The focus by some of our chambers has been to criticise the fiscal or monetary sector authorities, but yet fail to follow through, in this case with the commercial banks when those authorities enact the advocated for policies.
In conclusion, the Central Bank has done its part, it is now for the Chambers of Commerce to enhance their roles to lobby on behalf of the business community for lower lending rates from commercial banks.
About the Author
Kelvin Chungu is an Associate Director in the Assurance, Advisory and Business Development Service lines and can be contacted on 0976-377484.
