Commercial Bank Interest Rate Spreads (IRS) Are Legitimate Cause for Worry

(Published in Stabroek News on March11, 2011)

Guyana’s commercial banks are enjoying particularly strong success in the current economy with excellent bank liquidity positions and very substantial profit margins, a reality recently reinforced by Mr. John Tracey, CEO of the Guyana Bank for Trade and Industry (GBTI), at an event to launch the Global Trade Finance Program.   

Indeed, the financial and physical evidence everywhere shows just how well Guyana’s banks emerged virtually unscathed by the recent global financial crises and the credit market crunch. The magnificent and grand architectural structures that are home to corporate headquarters for these financial giants dominate the urban landscape as monuments to their strong positions. The government likewise has collected its fair share of tax revenues from this thriving industry. Banks also have expanded by opening branches to all areas of the country, the most recent being the GBTI and Republic bank facilities in the Diamond, East Bank area.

There is no doubt about the vibrancy of the nation’s banking industry but there is another side which must be widely acknowledged – the perniciously high interest rates on commercial investments and interest rate spread (IRS) as represented by the difference between the average interest rate earned on loans and the average interest rate paid on deposits. A recent check at five commercial banks – GBTI, Republic Bank, Demerara Bank, Scotia Bank, and Citizens Bank – reveals that the average interest earned on deposits amounted to 2.7 percent.

The average interest on commercial loans is difficult to determine because of its discretionary nature, which changes on a case-by-case basis. However, having personal experience in dealing with banks and conferring with my colleagues in the private sector, the average rate for strongly performing companies is around 12 percent. Meanwhile, the average rate for new businesses and high-risk projects hovers around 19 percent.

Numerous industry-based studies have shown that a high IRS signals a lack of market competition, limited potential for deepening the roots of the financial investment sector, the existence of perceived market risks, scarcer options for bankable projects, and regulatory constraints. Moreover, persistently high interest spreads can compromise investment and growth by way of low levels of savings, borrowing and investment.

In Guyana, banks operate in a restricted oligopolistic market with each holding similar banking offerings and rates. As a result, banks have enormous capabilities to maximise profits (lowering current after-tax profit margin targets would help reduce the IRS) and limit incentives for adopting unique or innovative policies to gain competitive market share. In the absence of any secondary market for government bonds and other securities – coupled with an undeveloped stock market – the public is left with no option but to keep their savings as bank deposits even despite the low interest rates being paid on those deposits.

In contrast, because of more aggressive competition, banks in other international financial markets are compelled to achieve higher levels of efficiency and operate profitably at lower interest-rate spreads (IRS). Imagine savings rates of four or five percent, mortgage rates below six percent and lending rates to large companies and small businesses below 10 per cent? In such conditions, the impact upon Guyana’s economy would nourish GDP growth as businesses expand and flourish in all of the nation’s key industry sectors.

The high IRS levels are unjustifiable because the intermediation costs, defined loosely as all the administration and operational costs incurred while offering its services, are not exorbitant and are usually accounted for through prohibitive fees and charges on all services; an anathema that almost every businessperson dealing with the banks can attest to. If the intermediation costs are high, then the banks are operating inefficiently and should review their operations.

As the incentive to lower IRS in an oligopolistic market is negligible, the intervention of Guyana’s central bank appears to be the only realistic option for reconciling this issue.  There should be a mechanism for more effective coordination between the Central Bank and commercial banks regarding interest rate and credit policies to ensure that the needs of the business sector and consumers for lower rates and access to credit are met. Only then can long-term sustainable economic investment be assured.

Realistically, no one should resent the commercial-banking sector members for seeking a fair return on their invested capital. However, resolving the problems of these high interest rate spreads will prove critical as narrower spreads could carry measurable economic benefits for all stakeholders in Guyana’s economy.