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[FT 21 Oct 1997]

The interest rate Pandora’s Box has been re-opened by the new Minister of Finance. Jim Ah Koy, very publicly, and with a very, very reluctant Reserve Bank dragged along, charged into the boxing ring against the powerful commercial banks.

The laudable objective of the Minister of Finance was to try to kick-start the economy, by encouraging investing borrowers, through a reduction of interest rates charged by the commercial banks.

First, the banks were going to do it.  Then they were not.  Now, no-one is sure at all.  Have the banks got their backs to the wall and are digging in?

These are all interesting questions, but firstly, should the banks lower their lending rate or increase their deposit rates?

Margins Too Big?

The public has a vague idea that banks are charging too much for their loans, and not paying enough on their deposits.  There is a view that the gap has been growing wider.  How valid are these claims?

Graph 1 gives the margins between the banks average lending rate (currently around 11.1%) and the interest they pay on firstly, their time deposits (which currently earn around 5.6%), and secondly, on their savings deposits (which currently earn around 3.2%).

What stands out, firstly, is that the margin on savings deposits has hovered around 8 percentage points, with no real upward trend.

But the margin on time deposits after decreasing up to 1995, increased sharply in 1996, although it has declined again in 1997.

The banks would no doubt justify the much higher margin on savings deposits by pointing to the much higher administrative costs involved in the savings accounts, relative to the time deposits.

But are the margins on savings and time deposits obtained by paying too low an interest on savings and time deposits?  One way of seeing this is by calculating the real rates of interest, by adjusting for inflation.

Adjusted for Inflation

Graph 2 shows that owners of time deposits have been enjoying a reasonably positive real rate of interest, which rose from about 1 percent in 1991, to about 6 percent in 1994, but has severely declined since then to about 2 percent in 1997.

Unfortunately ordinary small savers faced negative rates of interest before 1994, had small positive rates for 1994 and 1995, and just below zero again in 1997.

In other words, ordinary savings depositors, have been paying the banks for the pleasure of using the savers’ money.  This can hardly encourage people to save and put money in banks.

Are the banks following their interest rate policies because their profits have been threatened in these depressed hard times?

Banks Feeling the Pinch?

Not so.  The latest Reserve Bank Reports show that the commercial banks, excluding the NBF and Asset Management Bank, have been doing very well, thank you, for the last five years.

They have steadily increased their Net Profit Before Tax (as a share of Average Assets) quite dramatically from 1992 to 1996 (see Graph 3).   Their Net Profit (in dollar terms) probably increased by around 120 percent.

More importantly, the bulk of this increased net profit came from Net Interest Income which increased by nearly 70 percent, and Commissions and Charges which increased by almost 40 percent (see Graph 4).

This is extraordinarily good business, during a period when the financial system is supposed to have been facing something of a crisis, in terms of lack of borrowers, and stagnant volumes of loans and advances.

Indeed, the commercial banks this year have a record liquid assets margin, which has risen from around $23 million at the beginning of 1995, to about $105 millions in the middle of 1997.

Any other seller of goods or services faced with excessive stocks would lower their price- which, for the banks, is their lending interest rate- if they want to lend more?

Or, in the interests of equity, if some of the extra profits are due to improvements in productivity and efficiency, you would think that they would share the benefits with their staff or their depositors?

The Reserve Bank data indicates that the banks are not giving much to their staff, except perhaps to a select few through “other management expenses” (which probably also includes out of ordinary costs associated with the hiring of additional expatriate staff).

Given the significantly improved profitability of the banks, there is surely some room both for some lowering of lending rates, and some raising of deposit rates, especially for savings deposits.

But how does this occur?  Will free markets do it (as a trade unionist has claimed, somewhat surprisingly)?  Or is there room for intervention by some authority?  Should the Finance Minister interfere and demand a reduction of rates?

Which Authority?

There is no doubt that the Finance Minister has a legitimate right to be concerned that the interest rate should be at the appropriate rate for the economic growth and development of the economy.

But we also need to remember that Government is itself a big borrower in the money markets (although not from the Commercial Banks) and therefore very much an interested party.

One hidden problem in the economy (which has not become so obvious because of the recession in the private sector) is that Government, to finance its increasing deficits and public debt, is able to borrow from a captive FNPF at a considerably lower rate of interest than it could get from the commercial banks.

It is arguable that if more of FNPF money, were to be made available to the private sector, this would itself tend to push down interest rates.  But where would the Government get the money to fund its deficits and public debt, and at what interest rates?

What of the Reserve Bank?

Influencing the interest rate (and other monetary policies) is normally the prerogative of the Reserve Bank, through their usual techniques.  The Government should not be taking the lead role with the Commercial Banks.

Certainly, it could be an extremely unhealthy situation if the commercial banks were to face two masters, both of whom can legally affect the banks operations (though in different ways).

The new Permanent Secretary of Finance, himself recently seconded from the Reserve Bank, would be aware of this.  But is there more to Ministry of Finance initiative than meets the eye?

The textbook view is that the Reserve Bank can inject additional funds into the money market and thereby encourage the banks to lower their interest rates, through the workings of the free markets.

But for this nice theory to actually work requires healthy competition amongst the lending banks, and borrowers competing for funds (the ideal supply and demand interaction).

Is There Competition?

Certainly, there is some competition in the foreign exchange dealings (where the banks’ profits stagnated in dollar terms, and declined quite significantly, as a share of their total operating profits).

There is some competition in the housing loan market, where interest rates have come down slightly.

There is probably stiff competition for the big loans and the big deposits, where individual (important) clients are getting better rates all round.

But I doubt very much if there is any great competition elsewhere, as far as the thousands of small weak depositors and the thousands of weak small borrowers are concerned.

How else could the commercial banks steadily keep increasing their profits in the face of a very slack borrowers’ market and economy?

Cartel Behaviour

There is a more plausible theoretical explanation.  The very small number of banks (dominated by only two) have known that in the last five years or so, the demand for investment has been so slack that lowering interest rates (the price) will not have brought forward any significant increase in “bankable” projects (the demand) with the desired low levels of risk.

Very sensible commercial banks, in their own self-interest, will behave like monopolists and maintain the higher price (lending rate) and lower costs (deposit rates).

And the banks don’t have to get around a table in the dead of night to plan a “cartel”.  They simply “follow the leader”, who knows what’s good for them all.

Two or three competitors, who are unlikely to knock each other out through an interest rate war (which will benefit none of them in the short or long term) would be foolish to start competing on interest rates.

Fijihas seen similar behaviour in biscuits, cooking gas, petrol, etc., even if price wars do go for short periods.

So, what indeed can the Reserve Bank do, especially if the market has no shortage of funds and the Reserve Bank is afraid of fuelling inflation?  Is there room for “moral suasion” by the Reserve Bank?

It would be silly to expect commercial banks to voluntarily reduce lending rates and raise deposit rates, and lower their profits.  Millions of dollars are at stake, and the banks have ridden these storms before.

Public pressure could have an effect.

While we may not agree with the method, the last thing the public (including union leaders) should be doing is to demand apologies from a Minister of Finance who is trying to bring lending rates down.


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