Like a small boy who once asked, how can 22 grown men chase one small ball?; so are the many questions that often boggle my mind. Often they are issues concerning the economy and finance. I guess my inadequacy in the knowledge of Finance and Economy may be the cause. The child further asked, Dad why do you sometimes try joining the 22 men chase the ball? You move your leg and scream when passes go wrong. Children ask the most down to earth questions and a careful thought of those will make us rethink and their faith is unwavering. Daddy can answer all questions. I come again with some questions about this issue on Prime rate (Policy rate) and Bank Lending rates. Most of these questions emanated from the latest MPC report, and without referring to any other document, I would like to ask some questions, Daddy.
What is a Prime or policy rate? Per my friend Wikipedia, the term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case. This was articulated by the Governor of BoG in his speech as well. This is often adjusted due to changes in the macroeconomic situation of the country. Generally, Banks respond to adjustments to the prime rate as other risks may be valued and added to the prime rate (since prime rate is regarded as lending rate to a riskless person). When the prime rate thus increases, most banks increase their base lending rates and vice versa. Again base lending rates imply the prime rate+ bank admin charges+ bank interest any other the bank may wish (Wikipedia says Base Lending Rate (BLR) is a minimum interest rate calculated by financial institutions based on a formula which takes into account the institutions cost of funds and other administrative costs.)
From the above, if the prime rate is reduced, but the administrative cost is rising and the cost of funds is high, then should the bank base lending rate be reduced? If one side of the equation reduces but the others are rising, should the rate fall?
I just remembered I owned shares in some of the banks listed on our Stock Market. This means some banks are public companies, and to be listed on the Ghanaian Bourse, you must have attained a healthy financial record. Good profits resulting in favorable return on equity and others.
From discussions I have heard and read concerning the reduction of the prime rate, it’s likely many will demand for credit. But the other question is, will the increase in prime rate result in an increase in the supply of money for credit? Won’t a rise in demand for credit without a corresponding increase in supply make the cost of credit go high? Then again, the question of supply of credit arises. A bank can only supply credit based on the capital that it has. How many banks have been able to attain our $60 million capitalization requirement? Do we have the supply of credit to balance the demand for it?
Finally, I would quote from the MPC Report that announced the glorious reduction of the Prime Rate. Section 11 of the report talked about the Banking Sector Developments states that, “Non-Performing Loans continue to rise, posing some risks to the overall delivery of credit to the economy”. Section 14 also states that “Commercial Banks Real Credit to the private sector declined by 0.2% in 2009”. If Non-Performing loans rise, then there will be a negative impact on the financial health of the bank. The bank will thus reduce it’s credit and rather invest in risk free instruments like the Treasury Bills. What the MPC didn’t state was the increase in bank investment in treasury instruments as compared to the amount given as credit. That information will show the direction that the banks are heading to, and their reluctance to give out credit, hence supply of credit is reducing, whilst demand is high. It’s worth noting that bankers are smart, and they factor the amount of Non-Performing loans into the pricing of credit to customers. A high non-performing loan portfolio may increase the lending rate as we have seen the past quarters. What is causing the rise in non-performing loans? I read in the section 10 of this report about the reduction in public sector borrowing and in previous sections about the reduction in public sector spending. If suppliers of goods to the government are not paid for their services, then they won’t be able to pay for credits that they have taken on, and hence will be bad borrowers. Will the reduction of prime rate do anything much to them? Will it make them look better in the eyes of the banks that they owe?
Well, so should the reduction of the Base rate emerge due to the reduction in the Prime Rate?
