Misinformation, fallacies, reality about interest rates capping

Parliament has deferred a Financial Services amendment bill to introduce a lending rate ceiling for banks. The bill has met stiff resistance from Bankers Association of Malawi (BAM), commercial banks and Reserve Bank of Malawi (RBM) and MPs mainly from the ruling party. The government even issued a very misleading press release disapproving the amendment.

This is expected because they are an interested party. For a long time Malawians have complained about high interest rates. When reforms in the financial sector were taking place in the 90’s several foreign and local banks entered the banking sector. The expectation was that interest rates would go down because there would be competition, but interest rates have remained very high.

Banks pay their clients as little as 5% on their deposit / investment while they charge 23% on loans. They operate more like cartels with no real difference in their interest structure and services offered. They are all intent on making excessive profits by charging exorbitant interest rates to clients.

Even when RBM reduces the repo rate, commercial banks have been reluctant to reduce substantially their lending rates. Perhaps, RBM is partly to blame for not using moral suasion to have commercial banks meaningfully reduce their interest rates.

All this points to the fact that banks are in business. They have to make profits to meet their shareholders expectations. In so doing they have been exploiting their clients through exorbitant lending rates. Although they make billions in profit per year they have nothing to show for them. They are failing to extending banking services to rural areas, let alone bring innovative products like introducing deposit-accepting ATMs.

Interest rate capping itself is not bad at all. It is now common in many countries and is working well. To say that introducing interest rate caps could crash banks and the whole economy system in Malawi is to be mean with the truth. BAM president Paul Guta has given an example of Kenya and Zambia where interest capping nearly led to such a scenario.

What BAM is not telling the nation is what exactly the problem was. Why is the law successful in other countries like South Africa? Why has the banking system or economy not collapsed in countries where caps have been introduced? One needs to carry out an in-depth analysis of why the law failed in Kenya and Zambia, why banks failed to adjust themselves to the system and what type of caps were introduced.

In South Africa, the National Credit Act (2005) has set different caps for eight sub-categories of loan, each with their own prescribed maximum interest rate. In developed countries such as France, Germany and the USA now use some form of maximum level of interest rates. These caps generally target loan sharks and predatory lending practices and have increased in popularity since the onset of the financial crisis.

We know that there are several factors that a bank takes into account when determining interest rate such as the cost of funds, the lending risk, Treasury bill rates, rate of savings relative to borrowing, inflation and exchange rates, the bank’s administrative and operating costs.

Despite these factors banks are still making billions of kwacha every year. In fact, banking is one of most profitable sectors in Malawi. While other sectors of the economy are making losses or struggling, banks are making astronomical profits at the back of their clients.

Owing to market failure, it is justifiable for the government to intervene in the market and introduce interest caps so that banks and other micro financing institutions lend at lower rates knowing that the costs can be absorbed into their colossal profits.

Government has a duty to protect borrowers from excessive credit interest rates, to make loans more affordable and improve access to credit.  Malawian banks have exploited their customers for many years while government is just watching. It is unfair!

And there are some fallacies that need to be dispelled. These include interest rate cap will hurt the SMEs because they will be denied access to finance, banks will increase fees, government need to address borrowing. It is well known fact that banks do not lend to risky clients (farmers, self-employed and SEMs etc).

So the issue of alienating SMEs and other risk groups does not arise because banks are already alienating them.  The birth of village banks and other informal lending groups is a result of the failure of banks to extend credit to the SMEs and other vulnerable groups.

Government can only reduce, but not stop borrowing because it is one of the ways it uses to raise funds for development. Governments everywhere in the world borrow and Malawi is no different. Western governments, like Malawi, are saddled with sovereign debt. So government borrowing cannot be used as an excuse or justifiable reason to block interest rate capping.

The reality is that banks are afraid of interest caps because this would reduce their obscene profits not because the economy or banks will collapse. Banks are greedy. Every year they raise their charges for no justifiable reason. In South Africa, banks stay two to three years without raising bank charges because they know they are already making profits.

The Budget and Finance Committee should bring back the bill to parliament. Meanwhile they should consult widely and not just listen to BAM, RBM and other interested parties. Malawi needs interest caps to bring sanity to the banking sector.