By Omodele Adigun
“Since banks give interest rates that are much lower to their deposit clients, many of such investments today actually do not make sense,” says Mr. Tope Fasua, the Managing Director of Global Analytics Consulting.
Giving reason for this, he stated that loss of purchasing power is a critical factor in determining interest rate levels. And as a result of this, interest rates should be higher than inflation rate.
His words: “If interest rate is what one receives for giving money away rather than keeping it safe in the immediate term, it then follows that interest rates should be higher than inflation rate.”
In this interface, Fasua aired his views on many burning national issues.
Import Substitution is a strategy deployed by many Latin American as well as Asian countries decades ago, as a way of directly targeting where scarce foreign exchange may be hemorrhaging and blocking such by directing local production in that area. Import substitution is seen as a great way of diversifying an economy but as I argued somewhere recently, it may be a bit dated, and rather slow, because the dynamics of trade and global economics have become even more frenetic. Even developed economies are finding themselves reeling from the frequent sucker punches called creative disruption. While a country tries to stabilize its industries, some smart young chaps in Silicon Valley comes up with a clever little idea that renders all your efforts – and investments – almost useless or at best, suboptimal.
Look at the game around crude oil. Nigeria’s Platinum Bank thought it was clever to come up with an advert around cars running on water some day in the future. Well, the bank went down, but the idea of cars running on water has become reality much earlier than we expected. And owners of the crude oil resource are being warned daily of the imminence of their resource becoming useless. If we focus mainly on import substitution, we would be talking of building refineries. And that is what we are doing. But who knows how quickly these self-driven cars running on battery will make incursions here and take us out? We should never think that Nigeria is some out-of-this world backward country where good things could never make incursion. We have changed and are changing, in spite of ourselves. The world is changing us. Look at the way GSM took out CDMA phone technology as well as the cute little pagers we used to take around those days? What about the landline? Look at Uber and Taxify currently redefining the transportation space in Lagos and many other cities around the world?
So my advise, as I gave them on an NTA program recently, is that we broaden the scope of our discussions beyond import substitution and backward integration. We should understand that in order to get out of this tough patch where we have found ourselves, we will necessarily have to combine a handful of strategies. Our core strategy must see several years ahead and integrate our economy with the realities of the moment. Else we shall be left behind. Also we must know that our economic diversification strategy should not be about finding new sources of revenue for government, but new sources of revenue for every business and indeed every citizens, starting with improving the purchasing power of Nigerians.
The concept of default risk premium is self-explanatory. The higher the estimation of a default risk on the part of a borrower, the higher the lending rate charged by the bank. Recently, the concept of Credit Bureau is gaining grounds in Nigeria and banks are not supposed to lend except they do proper due diligence from at least two credit bureaus about a prospective borrower, and get an all-clear. The question is; why do we still have such a high rate of default in spite of this? Are banks keeping to the rules or bending backwards for favorite customers? Is there compromise somewhere along the line on the part of bank executives? Some credit bureaus are also working on credit scoring, so that Nigeria can operate like the developed economies where the fear of the credit score is the beginning of wisdom. This reminds me, that in my own experience, the concept of default risk is a reality as British banks offer credit at up to 35 per cent if they believe you need to work on your credit score.
Loss of purchasing power is a critical factor in determining interest rate levels. If interest rate is what one receives for giving money away rather than keeping it safe in the immediate term, it then follows that interest rates should be higher than inflation rate. If N1,000,000 today is only N839,500 in one year going by the current inflation rate of 16.05 per cent, it follows that whatever interest rate one receives on savings or fixed deposit investment should be HIGHER than 16.05 per cent for any such an investment to make sense.
Since banks give interest rates that are much lower to their deposit clients, many of such investments today actually do not make sense. Also it does not make sense really for banks to keep excess liquidity with the CBN at 9 per cent (14%-5%), except of course such investments are very short term in nature and are for the purposes of asset and liability matching. Also, even foreign investors holding Nigerian bonds with coupon rates below 16% (assuming they bought at par), have not made good investments except, of course, that they are insulated from the local economy and only watch the exchange risk. The relevant inflation to them is the inflation in their home countries which is matched against their total profitability.
The Monetary Policy Rate or simply policy rate as it is called in some other jurisdictions, is an indicative rate that is meant to drive the economy. It is the rate at which the central bank lends to or borrows from commercial banks and other clients, or the indicative rate around which it desires other rates in an economy to revolve. Sometimes the Central Bank does not set any policy rate apart from the risk-free or T-Bills rate. The risk-free interest rate is regarded as the rate for Treasury Bills, as different from the policy rate which is a monetary policy instrument. Treasury Bill rates will usually be more volatile than policy rates. Both of these rates inform the general interest rate level in a country and what banks charge their customers, as well as what customers should accept from banks for deposits.
We must note however that this doesn’t quite work in Nigeria. Why do banks offer much lower deposit rates than the risk-free (and they don’t have as much credibility as a country’s central bank),and much higher effective interest rates on borrowing? Already a report came out to the effect that banks are losing deposits to the very attractive treasury rates. Beyond textbook theories about how interest rates work, there are complications every step of the way.
The banks have complained of sterilizing too much of their deposits in statutory reserves. They also complain of other expenses like the NDIC premium paid as insurance for depositors. They seem to have moved on from complaining about generating sets and diesel, and we can see the effect of artificial intelligence in the banking sector whereby many have been laid off and replaced by e-banking, and ATMs. The CBN as the regulating body has set the statutory reserves at the level where it is presently, based on past experience with bank failures. On that issue, the banks can only continue to negotiate with the regulator, and also using its own internal parameters and where ordinary citizens see fit, we can also weigh in. I particularly support the sterilization of public sector funds because the previous regime led to too much profiteering on the part of top public sector executives and bankers. That regime also saw the deliberate sub-optimisation of public sector funds which are often held in fixed deposit accounts while projects remain abandoned.
So with personnel costs shrinking as a result of layoffs, and a number of branch closures due to a very shrewd era of new rationalisations, what excuses do the banks retain for their high interest rates? To make matters worse, a handful of banks seem to be having an effervescent business cycle with huge profits being declared yearly, even as the rest of the economy is comatose – especially the SME sector. We have also seen many high-profile cases of bad bank credits like Etisalat, and many others, that get people thinking whether the banks deliberately shunt the due diligence processes of cross-checking credit-worthiness at Credit Bureaus or whether there is unholy collusion between bank workers, management and their heavily leveraged clients. These are peculiar issues in Nigeria.
Which way forward?
Nigeria is still reeling from an accusation leveled by one Senator against the Police, alleging that the top echelon of our police collect ‘protection money’ from banks, oil companies and other serious organisations, for the deployment of police operatives, monies which are unreceipted. It is extraneous expenditures like these that ramp up cost of doing business in Nigeria. The World Bank Ease of Doing Business Report documents factors such as ease of registering property, ease of obtaining credit, ease of liquidating a company, protection of minority interests, cross-border trading and so on, which do not have direct bearing on the business of banks. I have advocated elsewhere that we should be bold enough to document the cost elements that give our businesses nightmares here, especially our SMEs. In Nigeria things like police protection, and the plethora of corruption that big businesses especially face when they want anything done, are what racks up cost of doing business.
Also, we need to consider the cost of doing business in a generally inefficient environment where standards are disregarded and there is no commitment to service excellence. We all have a great work on our hands to ensure that Nigeria gets to the level where other progressive countries are; a point where everybody does his/her job perfectly without any prodding or financial inducement. For now, that is not the case and the banks – just like other businesses in Nigeria – bears the cost of systemic inefficiencies, thereby necessitating high interest rates. There is a need for us to work on our culture as a people.
Crashing interest rates
The CBN can only try and control the economy by keeping an eye on inflation. That is why, given the difficulty in taming interest rates, the central bank has tried to incentivize some critical sectors by offering credit at a concessionary rate of 9 per cent. We may not expect the CBN, through its Monetary Policy Committee, to reduce interest rates just because it wants to look good. There is a big risk that a reduction in interest rates will put banks under pressure to lend huge amounts just to stay profitable, thereby leading to moral hazards as Non-Performing Loans spike and the banking system itself comes into jeopardy. Of course a spike in bank credit leads to uncontrollable increases in Money
Supply, causing the Naira to lose value as inflation increases beyond manageable levels. The bank however needs to ensure that end-users get intervention funds at the concessionary rates and that middle-men don’t come in-between to profit from the well-intentioned idea.
Also we can apply the theory of Self-Fulfilling Prophecy here. It is the role of regulators to ensure that positive news goes out on the economy and that good news reinforces itself. So the CBN must not relent in ensuring that the market is encouraged to lower inflation rates. The CBN must continue to double its efforts by managing information tightly in the marketplace in such a way as to stabilize the banking industry. There are many players who would prefer upheavals and volatilities because arbitrage opportunities are not many in periods of stability. Those are the arch-enemies of the CBN, who can only be fought actively through a robust system of information dissemination.