Why banks will not bring down lending rates

by R. M. B. Senanayake
Bankers and government officials addressed a recent seminar on interest rates where the focus was on why the banks won’t bring down the lending rates to those whom they consider sub-prime. The whole question revolves on the gap between the lending and deposit rates paid by the banks. A leading banker insisted that the banks need at least a 4% spread. But in fact the spread is very much more being about 7-8%. The bankers have the best of both worlds. They can push down the deposit rates paid to savers who invest with them while they can also determine what rates of interest to charge on their loans.

Importance of credit to economic growth

If there is to be a quickening of economic growth this problem must be addressed by the government and at last the government seems to be taking notice. Credit is important and the shorter the credit cycle the greater the pace of economic activity. The Japanese have the lowest working capital to sales turnover, which is about 10%. But this ratio in our businesses is 30-35%. The Japanese introduced ‘Just in time production’ to minimise moneys tied up in stocks and hence working capital. If we are serious about economic development we must shorten the credit cycle.

The biggest culprit of course is the government. Mr. Rienzie Wijetilleke the Managing Director of HNB has said that while the banks finance the credit needs of the businessmen, they find that the government won’t pay bills for 3-6 months. This must be a world record. In fact Mr. Wijetilleke blamed the high lending rates on this delay in government payment procedures among other factors, according to a newspaper report.

Government responsible for extending the credit cycle

During colonial period public officials were required to settle bills promptly and I believe there was a Financial Regulation to that effect. But those were the days when there was no separate category of accountants in the public service. Senior clerks well versed in the financial procedures handled payments. With the proliferation of accountants the settlement of bills in the public service has been delayed. It is not that there is a shortage of cash since the Central Bank is raising all the money to be borrowed by the Treasury. Nowadays even Heads of Departments are afraid of their accountants when the Financial Regulations clearly make them the Accounting Officers not the accountants. This is because the accounting function should be confined to record keeping. The accountant could advise the Head if the financial procedures are not being followed but he cannot delay vouchers raising queries from the suppliers merely to delay payments.

Corruption has engulfed the entire public service. The government is still the largest economic player and all foreign aid will flow through the government. So while blaming the banks for the high lending rates the government must instruct the accountants and supply officers not to delay payments. A deadline should be given for settling all bills and if the payment cannot be made because the supplies don’t conform to specifications, the government should insist that they be returned without holding up payments. The whole trouble is the bureaucracy is not accountable for inaction that no disciplinary action is ever taken against inaction. The disciplinary rules must be overhauled removing the unnecessary interpretations introduced over the years. The higher officers should be dealt with and sacked where they are guilty of grave misdemeanours. Those who do not supervise or fail to take action should be retired for inefficiency without elaborate procedures.

Over-borrowing by the government

To return to the subject of high lending rates, Mr. Wijetilleke has blamed the general inefficiency and lethargy in approving projects. So although there is a surplus of liquidity and very low interest rates for depositors there is neither a significant increase in credit to the private sector nor a reduction in lending rates to them. The banks prefer to invest their surplus funds not in lending to the businessmen but to the government. In spite of the promises to bring down the public debt, the government borrowing requirement is continually rising. The government rightly blamed the previous regime for excessive borrowing but it has not changed course. It will end with a much large public debt than when it assumed office. This means the banks don’t have to take risks lending to the private sector when they earn enough on risk free investments in government securities. So the easy liquidity situation will not lead to any significant increase in the credit off-take.

The large corporate borrowers are able to access the banks funds at comparatively low rates of interest. But any economy consists of over 90% small and medium enterprises and this is true even of the US. By catering only to the few corporate firms the banks are not promoting investment in the country. The banks are mobilising the funds of the people and if they do not invest them in the private sector then it is useless talking of the private sector being the engine of growth.

Banks in a cartel?

Competition among the banks has not reduced the spread between the borrowing and lending rates of the banks. The CEO of the Hatton National Bank says the banks want a minimum of 4%. But the fact is that the spread is much much more and is as high as 7-8% on the loans to the small and medium sector. It is not as if the big corporates are without risk. In fact the bigger the customers borrowings from the banks, the greater the risk to the banks since if they fail they can bring down the bank as well. An examination of the Balance Sheets of the big corporates shows that they have over-borrowed judging by their debt equity ratios. In fact many companies are paying all their earnings to the banks rather than to their shareholders.

So there are several structural constraints, which have to be removed before the market for loans will drive down the rates of interest. The government has a crucial role to expedite payments from government departments. Any improvement on this score will improve the productivity of the whole economy as a larger volume of business can be sustained over a shorter period of time. Productivity, critical in the globalised economy, is a major area where we are lagging behind. Whether our garment industry will survive after 2005 will depend on its productivity. The productivity of any firm will also depend on the macro-economic environment which must be conducive to productivity and not be a drag on it.

Bad Debt hang-over

The other great problem, which keeps the lending rates of the banks high, is the huge bad debt hangover or the non-performing loans. Action must be taken to force the banks to write off such bad loans and transfer them to a new Asset Management Company which will pay the banks whatever such loans fetch. Of course our judicial proceedings are another big obstacle to clearing up these loans. The parate execution procedure should be made available to those who wish to buy such non-performing loans as in other countries. Until the bad debt hangover is removed the banks will not be forthcoming with loans to the small and medium enterprise sector.

Excessive costs of the banks is detrimental to business

The CEO of the DFCC Bank admitted that the problem of high lending rates is due to the excessive cost structure of the banks. In recruiting staff the banks have never followed the market. They have paid excessive salaries to clerks and executives who acquire knowledge of banking in-house. The management of banks are overawed by the trade unions in boosting the salaries of the staff. The higher management do not resist the excessive claims made by the trade unions because it helps them to justify higher salaries and perks for themselves too. The banks are owned by nobody. As the CEO of the Hatton National Bank pointed out there are no controlling shareholders in the banks owing to the cap on shareholdings of 15% imposed by the Banking Act.

It is not worth the while for the widely dispersed shareholders, each with only a small percentage, to undertake the task of monitoring the managers. So there is no monitoring of the managers by the shareholders. The Reserve Bank of India insists that the salaries of the bank staffs should be approved by it. In this way the Reserve Bank prevented the bank managements from voting themselves and their staff excessive salaries. The burden of staff costs in the banks is ultimately carried by the business community by way of paying higher and higher lending rates. If the Central Bank caps shareholdings then it must step into the task of monitoring the managers.

The banks now want to promote mergers among themselves to reduce competition arguing that the bigger the bank the stronger it would be. This of course is not correct. Big banks like Continental and Barings have collapsed as well as small banks. The important issue is the principal-agent relationship where the agent is made accountable to the principal. Research has shown that a holding company can enforce better monitoring of the bank managers than normal controlling shareholders. Is it any wonder that a leading commercial bank opposed the DFCC Bank from setting up a holding company?

If the government is keen to bring down lending rates it should not only expedite government payments but also clamp a windfall profits tax on the banks as the UK government did. There is no reason bank employees should profit at the expense of the business community and the depositors.
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