2017: The year interest rates softened

It has been a good year for borrowers, at least when compared with the previous years.

The year 2017 closed with the policy rate—the rate at which commercial banks borrow from the central bank as the lender of last resort—at 16 percent, as compared to 24 percent in December 2016.

Base lending rates for some commercial banks lowered to 23 percent, compared to an average of 33 percent across banks in December 2016.

For the first time in years, the Reserve Bank of Malawi (RBM) lowered the policy rate three times in a year, thanks to the easing inflation, among other things.

Helped by declining food prices, a relatively stable kwacha and lower international fuel prices, overall inflation declined from 18.2 percent in January to 7.7 percent in November 2017.

This downward trajectory of both food and non-food inflation provided scope for monetary policy to start unwinding.

The falling interest rates—holding other factors constant—are expected to improve access to credit by the private sector, thereby improving economic activity.

The lower interest rates will also lead to a reduction in the interest payment bill of future government budgets.

However, despite the reduction in the benchmark rate, some commercial banks were inelastic to adjust their base lending rates and still posed a risk premium on borrowing, a development which still prohibited borrowing for long-term investments.

RBM Governor Dalisto Kabambe, however, affirmed that as the central bank, they will ensure that commercial banks pass on the benefits of the policy rate cut to their customers to boost economic activity and create jobs.

He said: “We are hopeful that commercial banks will respond to this cut and we will follow up to ensure that they are responding because ultimately we want to ensure that commercial banks pass on this cut to economic agents across the country.”

Economics Association of Malawi (Ecama) executive director Maleka Thula said the reduction in the policy rate and subsequent cuts in interest rates was a welcome development considering that most macro-economic indicators were performing favourably.

“It now remains imperative for the private sector to leverage on the prevailing favourable macroeconomic conditions to support the country’s growth,” he said.

Overall, the developments in the monetary policy in 2017  have been forthcoming, considering the tough economic environment that the country had to endure in the previous five years.

High interest rates affect consumer and business confidence. A rise in interest rates discourages investment as it makes firms and consumers less willing to take out risky investments and purchases.  Countries with high interest rates also attract less foreign direct investment (FDI).

High interest rates also affect commercial banks as they increase the level of non-performing loans (NPLs)-those loans that borrowers are no longer making payments on.

These types of loans are close to being considered in default, and on the verge of being written off and absorbed as a loss by the bank.

The RBM 2016 Financial Institutions Supervision report showed that NPLs in 2016 increased by 69 percent in 2016 compared to the previous year.

The intervention of the central bank within the year also led to the increased interest rate on savings, with some commercial banks having their savings rate above the inflation rate, thereby giving people value for their money.

Kabambe highlighted that a large interest rate spread—the gap between the interest rate charged on loans and interest charged on savings—is an indication of inefficiency in commercial banks and urged the banks to restructure themselves so that they offer loans at a low cost without affecting their operating profits.

“What this entails for commercial banks is that they need to improve on their cost structures and restructure themselves. Sometimes we need to relook at the bonuses, dividends and salaries,” he said.

The cost of funds, according to Bankers Association of Malawi (BAM) is affected by the cost of deposits, the liquidity reserve and cash in treasury, operating costs and non-performing loans, among others.

Considering that commercial banks remain the largest providers of financial services, the duty lies upon them to leverage on the reducing base lending rates and increasing savings rates to bring more Malawians into the formal financial sector and improve the country’s saving rate from the current 2.9 percent of the gross domestic product (GDP) which is far below what is needed for developing countries to grow.

Commercial banks will also have to consider that they are now competing with village savings loan groups to provide credit mostly to small and medium enterprises.

Nevertheless, thumbs up to the RBM for the better interest rate environment.