Sunday, December 10, 2023

In an economy one loses, the other gains

As with any economic set up there are both losers and gainers, and under the new lower interest rate space, brought about by the Central Bank, the situation is no different. 

Between 2015 and 2017 Bank of Botswana has reduced the bank rate by 2.5 percentage points from 7.5 percent to the current 5 percent. BoB Govenor, Moses Pelaelo, last week Tuesday made public that the Bank had moved to cut the bank rate from the prior 5.5 percent to 5 percent. Commercial banks are expected to make the necessary interest rate adjustment, which is lowering their prime lending rates, in response to the Central Bank’s bank rate reduction. 

The move by the Central Bank is set to gain the economy of Botswana, businesses and first time borrowers but the losers are the commercial banks, savers and pensioners whose income generation is reliant on interest. 

The current state of the economy according to BoB is depicted by one, very low inflation, which if it will pick-up it will likely do so at a modest pace, and two, very weak economic conditions. This led BoB to reduce the bank rate so as to lower the cost of borrowing by commercial lenders the result of which is that borrowers, especially businesses, will find it attractive to take out loans. The Central Bank expects that when businesses borrow they will then inject life into the economy through productive activities. It is believed that the economy will benefit from increased productive activities whose output will spike growth to it; businesses too are anticipated to benefit from the favorable cost at which they will access loans and so will first time individual borrowers. Existing bank customers also stand to benefit because if for example such a customer has taken out a mortgage their repayment amount at the new rates will decrease or if they decide to continue paying back the same amount then the period in which they’re expected to have paid back the loan is reduced.   

This however puts the commercial banks, savers and pensioners out in the cold because at lower interest rates income earned reduces. Commercial banks earn income from the spread between the interest they charge on loans and that paid to depositors, which means that for them to make money the interest charged on loans must be higher than the one they pay to savers. With interest rates lowered it means that their spread is likewise thinning, leaving them to make much less money. The unfavorable position banks finds themselves in affects savers and pensioners because the interest they’re willing to pay them becomes compromised in their attempt to maintain a profitable spread.    

The scenarios demonstrated provide a straightforward loss and gain situations, but beneath the broader benefit of a lower borrowing cost lays nuances. This is because there are other determinants to the rate that is charged borrowers. According to expert analysis “additional determinants of interest rates including the length of time money is lent, the extent to which there is a risk that lent money is not fully repaid, and the extent to which money loses its purchasing power over time,” go into the rate charged individual borrowers. This speaks to the creditworthiness of the borrower, and whether the loan is attached to a security which in the event the borrower fails to pay back the loan can be used as compensation. “All else being equal, the rate on a loan to a higher risk borrower should be higher, and the rate on an unsecured loan such as a credit card should be greater than the rate on a secured loan such as a mortgage.” This means that it’s possible, despite the low interest environment, for banks to charge higher interest rates to borrowers based on their creditworthiness. In some cases banks may not give out loans at all.



Read this week's paper