For as long as I can remember borrowers, policy makers and in some instances even lenders have all been equally unhappy about the level of interest rates for one reason or another. For borrowers and policy makers, there has always been an inkling that interest rates ought to be much lower, more affordable than they are. They argue, and rightly so, that lower rates will promote businesses access to working capital and fuel business activity; production, consumption, jobs, economic growth etc. The reality however seems to be different; rates are consistently perceived as high, and lamented as much across microfinance institutions, microfinance banks, commercial banks, SACCOS even your neighbourhood VIKOBA. Indeed no lending institution has been immune to this criticism.
In this article we take a step back and reflect in a simple manner on what it shall actually take for us to see truer rates. But what do we mean by “truer” rates? This simply means interest rates that are more “reflective” of the ongoing market fundamental conditions. Interest rates reflect a price; the price at which money of the same currency exchanges hands between agents across time. An efficient price should be reflective of the ongoing fundamentals in the market.
For instance, the price of a kilo of maize fluctuates throughout the year. With the price per kilo being lowest during times of peak or bumper harvest and highest during off (planting) season or during high demand. The interest rate, the price of money too should reflect the supply and demand of money and available liquidity in the market. Our challenge locally is rates are perceived as high both in absolute terms and relative to prevailing fundamentals. There seems to be a misalignment.
Below are some of the initiatives that can help us see truer rates in the market:
Transparency, virtually synonymous with truth is a key cornerstone. But what do we exactly mean here? As lending already happens through binding legal contracts across the market in a willing borrower willing lender scenario. What is meant here is beyond lender borrower transparency but systemic transparency. The benchmarks for lending, the language and standard clauses to be transparent and universally accepted.
Any interest rate charged to a client is a product of the particular lender’s cost of funding, their credit risk margin and profit margin. Currently most institutions capture these in their “base rate” which is vague and differs from one institution to another.
The cost of funding for an institution is the most misunderstood variable. It varies from bank to bank in naming, construct and context. It is influenced by several factors such as cost of raising deposits, deposits currency mix, cost of capital etc.
Undertaking research on the cost of funds methodology across the industry with a view of standardizing its nomenclature, construct and context in line with best practices may help us produce a common cost of funds methodology anchoring market interest rate pricing. Borrowers/lenders will be able to compare pricing and institutions with lower cost of funds shall have added pressure to price lower (credit margin and risk margin being constant) than is the case now, where in some instances those with lower costs of funding may very well be pricing more expensively on some products.
In trying to simultaneously address financial inclusion and financial protection in the US in the 1950s/60s the Truth in Lending Act (TILA) was introduced. In it, among other things, the legislation stipulated the agreed standard rate benchmark to be used to openly communicate what the interest rate is on any lending.
This made the rates immediately openly comparable across institutions and creates the pricing pressure to align with market conditions whether market conditions reflect increasing or decreasing rates. In this instance based on our current market conditions in Tanzania we would have seen significant downward pressure on lending rates.
Follow the leader
Two institutions in our banking sector have about 40% market share of the total loans. Changing and influencing market pricing standards must start with them. In the absence of a credible transmission mechanism from lower treasury bill rates and policy rates to lending rates our market has always tended to follow the leader. When the bigger players show credible signals that they are pricing downwards (or upwards) across their portfolio the rest tend to eventually follow suit. It would not surprise me if policy makers make specific efforts in engaging these banks in the spirit of moral suasion as a route to transform the market to truer interest rate levels.
Technology, our friend
Since the advent of mobile money technology financial inclusion has significantly improved. Money transfer, cash in and cash out via agency networks have traditionally been the main staple services. Recently though there has been an increasing number solutions offering loan products through the synergies of bank and telecom business models.
Whilst this mainly covers personal lending and at smaller amounts, things are in motion. More use of platform lending that makes use of credit data and models has the potential to be scalable to small businesses and beyond. Therefore actively promoting the innovation from sector and non-sector players, especially related to lending platforms shall help see more transparent and competitive lending solutions.
Independent Consumer Protection Bureau
Recently the central bank has made commendable efforts in promoting consumer protection. A consumer complaints desk, a consumer protection regulation and now a consumer protection division have taken shape. As these efforts set a benchmark and bear fruit we need to transition this initiative to an extended value chain of players via an independent body. It may help in the long term to form a Consumer Protection Bureau of sorts manned by experienced bankers, lawyers and researchers to carry on this mantle of consumer protection advocacy, sector research for improved legal and operational frameworks, and financial awareness in the financial sector.
I believe a mix of the above initiatives will help us see “truer” rates. Rates that respond and reflect prevailing market conditions quicker and more transparently than is the case now. This is the elusive first principle for policy makers upon which a lasting victory to produce lower interest rates must be premised on.