On the President’s directives, commercial bank lending rates are likely to come down now. Interest rate is the cost of borrowings and, for that matter the cost of business investment. Therefore, lower interest rates together with simplified lending procedures make business easier in contributing to economic growth.
When state banks reduce the lending rates, private commercial banks and other lending institutions will have to follow to remain competitive. When the lending rates fall, the deposit rates should fall to even lower levels because the difference between lending and deposit rates constitute part of the bank profits. While what should be the feasible reduction in interest rates and how long it can be sustained are issues for concern, one may wonder why the commercial banks were reluctant to reduce their lending rates so far against the relaxed monetary policy stance of the Central Bank.
Given the decline in domestic inflation in the recent past, the monetary authorities had an easier time to relax the monetary policy stance. According to a Central Bank press release on April 22, 2009, policy measures were taken to ease monetary expansion and to reduce the policy interest rates against the continuing decline in the general price level and the domestic demand. But commercial banks were reluctant to follow the suit. As Figure 1 shows, for instance, the 91-day Treasury Bill rate recorded a steady decline from over 17 % in late 2008 to below 11 % by July 2009. But the commercial bank lending rate continued to remain around 20 %, the deposit rate has declined by about two points, increasing the bank’s profit margin. The issue is how was it possible for commercial banks to remain in business while keeping the lending rates high?
In fact, the commercial banks also had an easier time to reduce the lending rates and expand credit, because their deposits have increased significantly. The increase in bank deposits was also contributed by the transfer of deposits by the customers who lost the confidence over private financial companies which went into troubles. Presumably, a large part of these funds may have gone to the state banks. As Figure 2 shows, the bank deposits continued to rise at an accelerating rate exceeding reaching 6 % growth in the second quarter of 2009. However, the banks’ credit expansion has slowed down constantly from about 4 percent in the second quarter of 2008 to a negative growth by the second quarter of 2009. Apparently, the banks had to be cautious about private lending due to the adverse impact of the global economic downturn as well as the increase in non-performing loans. Nevertheless, the banks had a safe investment in government securities because the government, as the biggest borrower in the country, continued to borrow.
Investment in government securities has increased at a higher rate than bank credits recording 15 % growth in the first quarter of the year, and reaching nearly 30 % growth in the second quarter. With this development, the Central Bank’s relaxed monetary policy stance appears to be meaningless since its benefit was absorbed by the government, and not the private sector.
The low interest rate regime can be sustained only if the government helps to sustain it.
If the government continues to borrow as it did in the past, the investment funds that would be available for private borrowings would be exhausted by the government itself.
For the same reason, if the inflation rate is to pick up again the interest rates cannot be held at lower levels.
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