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Towards low interest rates in Tanzania: What does it take?

Saturday July 17 2021
BOT PIC
By Honest Prosper Ngowi

Debates on interest rates are not in short supply in Tanzania. Among the relatively new trigger of discussions in the interest rates space is the call by President Samia Suluhu Hassan on the need for the Bank of Tanzania (BoT) to reduce lending rates, which are rather high in absolute terms and in relation to the rate of interest on deposits.
One wonders why the lending rates are that high in this seemingly competitive industry with over 40 banks and a multitude of non-banking financial institutions competing with these banks for relatively few customers.
As BoT works towards decreasing interest rates, it is worthwhile knowing why the rates are that much high in order to know what it would take to lower them.  

High rates
Interest on lending is the cost of borrowing. High interest rates are not good for borrowers. They increase the cost of borrowing and all that is associated with high cost of borrowing. It can increase cost of doing business, it fuels inflation and hold economic growth back. High rates may hinder access to finance thereby reducing financial inclusion.
On the other side, lower rates are generally good for the economy. However, there are several factors that cause high interest rates. If the rate is to go down, these factors have to be addressed as partly outlined here.

Production costs
Interest rate is the price that financial institutions charge for their core business which is lending money. As for other businesses, it costs to conduct banking business.
Therefore, financial institutions have to charge ‘adequate’ price (interest rate) to be able to cover their costs and at least break even.
Cost drivers interest charged by banks’ lenders, staff, infrastructure broadly speaking, insurance, cost of technology, compliance costs, fees including rental fees for business premises and much more. Without reducing some of these costs it will be a tall order to reduce interest rate and remain profitable.
 
Profit
Financial institutions including banks are profit making entities. They aim at making and maximizing pecuniary (monetary) profit. They therefore have to charge a price in the name of interest rates in order to cover their costs and make a ‘reasonable’ profit margin. Therefore, lowering profit targets may contribute in lowering interest rate.

Inflation
Time value of money is critical in banking. Inflation therefore is among the fundamental drivers of high interest rates.
This is mainly so in inflation-ridden economies. In order to protect the value of the money they lend, lending institutions have to charge inflation-adjusted interest rates.  Therefore, interest rate can go down if inflation goes down sustainably, other factors remaining constant.

Demand side economics
Another possible explanation for rather high borrowing interest rate is high demand for loans. Economic theory predicts higher prices (in this case higher borrowing interest rates) if there is high demand for the good or service being sold.
Of late, it has been banks that are seeking for borrowers than in the recent past when the opposite was the case.
With over 40 banks and many non-banking financial institutions in Tanzania, it seems that the supply side of loans is bigger than the demand side.
One would expect lower interest rates as it has been the case in the mobile phone tariffs.
This paradox indicates that the ceteris paribus conditions in the economic law of supply of and demand for loan does not hold.

Credit Reference Bureau
Lending is a risky business. One needs to take calculated risk before lending money. The amount of risk depends on appetite for risk on the part of lenders. Among the risks that lenders carry is that related to Non Performing Loans (MPLs).
Credit Reference Bureaus (CRB) are very important in de-risking loans and by extension in reducing interest rates.
With well functioning CRB system, lenders will have good Know Your Customer (KYC). This include knowing borrowers’ borrowing and repaying discipline. The more the KYC the lower should interest rates be.

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Ways forward
The need for lower borrowing interest rates in Tanzania cannot be overemphasized as partly captured by a number politicians over time. To attain lower interest rates however is a function of several variables as partly outlined in this piece.
All involved stakeholders have a portion to contribute in the bid to attain lower interest rates in Tanzania.