interest-rates

…it is far better – and more reasonable and feasible – to achieve a 15 percent growth of the overall economy year on year, while living with double digit interest rates and double-digit inflation. That is what we should be targeting for now. There are too many sectors of the economy that can do a lot better but are being ignored today.


This subject is a major concern for many Nigerians, especially the business community. Many say that the biggest issue facing Nigeria today is the high lending rates, but I don’t subscribe to that view. Credit is not a sufficient condition for business success. There are other factors, and especially for startups, it may be important to look at other areas apart from bank credit which is presently high and stifling. Most small businesses start with family and friends helping out in the beginning. This means you have to be known by family and friends as a person of integrity, and you also have to have enough passion and commitment to speak about your business idea and be able to convince those close to you, to give you a chance.

All the same, let’s explore the many reasons why it is difficult for Nigeria to achieve low lending rates. I have noted already, that deposit rates are also quite low and the spread between the two (sometimes up to 25 percent, is unheard of in any other part of the world). This is one of Nigeria’s unfortunate peculiarities.

What Is Interest Rate?

Interest rate is defined as the compensation received for deferring consumption, or the cost incurred for consuming when resources are not available. People are faced with the decision to either save or spend, or to borrow or defer a purchase. Interest rate is the common denominator in these decisions. It follows, therefore, that for units with surplus funds, the market determines what interest rates they will be willing to receive, and the same market determines the interest rates that borrowers will be willing to accept. The intersection of the two curves is where interest rates should be determined.

Figure 1 - Fasua

 

Figure 1Ideally the intersection of demand and supply for money is the interest rate

But it’s usually not as simple as that.

The works of Robert Shiller, George Akerlof and Joseph Stiglitz on information asymmetry show that markets may not in all instances be the effective mechanism for price determination, because in many situations, some participants know a just a little more about the realities of the market than others. A used car salesman knows more about a car on offer, than a walk-in buyer. Managers and boards also know a little bit more about a company than its shareholders, and borrowers usually know more about their repayment prospects than the lender. For this – alongside Michael Spence – these gentlemen were awarded the Nobel Prize for Economic Science in 2001.

Theoretically the below are the determinants of interest rates

1. Supply of and demand for money;

2. Length of time money is lent (maturity premium);

3. Risk of non-repayment (default risk premium);

4. Loss of purchasing power (real and expected inflation);

5. Liquidity premium;

6. Risk-free interest rate;

7. Policy Rate.

If the simplistic example above explains the supply of and demand for money aspect, the concept of time value too can also be fairly easily explained. According to the Liquidity Preference – or Opportunity Cost Theory – people will naturally demand a higher interest rate for their funds to be tied down over longer periods of time.

Default Risk Premium

The concept of default risk premium is self-explanatory. The higher the likelihood that a borrower will not repay, the higher the lending rate charged by the bank. Recently, the concept of Credit Bureau is gaining ground in Nigeria and banks are not supposed to lend except they do proper due diligence from at least two credit bureaus about a prospective borrower, and get an all-clear. The question is: Why do we still have such a high rate of default in spite of this? Are banks keeping to the rules or bending backwards for favourite customers? Is there compromise somewhere along the line on the part of bank executives? Some credit bureaus are also working on credit scoring, so that Nigeria can operate like the developed economies, where the fear of your credit score is the beginning of wisdom. I can confirm that banks in UK charge as high as 35 percent on small lending to high risk clients, especially on credit cards.

Loss of Purchasing Power 

The loss of purchasing power is a critical factor in determining interest rate levels. If interest rate is what one receives for giving money away, rather than keeping it safe in the immediate term, it then follows that interest rates should be higher than inflation rate. If N1,000,000 today is only N861,995 in one year going by the current inflation rate of 16.01 percent, it follows that whatever interest rate one receives on savings or fixed deposit investment should be HIGHER than 16.01 percent for any such an investment to make sense.

Since banks give interest rates that are much lower than this to their deposit clients, many investments today actually do not make sense.

Nigerian banks insist that having sterilised a large proportion of their funds, they are desirous of making some positive real interest rate since they operate within Nigeria. Hence the high interest rates they charge on loans. The banks, however, negate themselves when they compete on profitability rather than stability.


Liquidity Premium

By ‘liquidity’ we mean the ability for someone to sell an investment to another buyer, like it happens in the stock market. Liquidity premium as a factor for determining the interest rates means that lenders consider the comparative liquidity of an investment instrument in setting interest rates. If many players are in a market constantly buying and selling a product, the price will be lower in general. Same for an interest rate in a market like, say, London or New York, where many players are present. The Nigerian money and capital markets are not that liquid.

Monetary Policy Rate

The Monetary Policy Rate or simply ‘policy rate’ as it is called in some other jurisdictions, is an indicative rate that is meant to be a reference point for commercial banks. It is the rate around which the central bank lends to or borrows from commercial banks and other clients, or the indicative rate around which it desires other rates in an economy to revolve. Sometimes the Central Bank does not set any policy rate apart from the risk-free or T-Bills rate. The ‘risk-free’ interest rate is regarded as the rate for Treasury Bills. They are called ‘risk-free’ because it is believed a government could never default. They will at best print money and pay their creditors.

Figure 2 - Fasua

Figure 2Further samples of risk-based rates from Nigerian banks

Interest Rates and Inflation – Relevance of Real Interest Rate

It is highly imperative to consider the concept of inflation rate, because this is the determinant of the real interest rate. Real interest rate, according to the Fisher Equation, is the nominal (book value) interest rate, less inflation. Any critical investor should consider inflation in their decision-making because at the end of the day, whatever the final gain on their investment will have to be subject to local purchasing power.

In Nigeria, therefore, with inflation at 16.01 percent – which is an achievement in itself – most real interest rates are in the negative. And where real interest rates on investment is positive, the figures are usually low and discouraging. A fixed deposit or an investment in government-backed instruments at 18 percent per annum will only yield 1.99 percent (18 percent-16.01 percent) in real returns before tax where applicable. Does this make sense?

Foreign Portfolio Investors Scenario

For foreign portfolio investors, their core concern is exchange risk and their profitability is matched with their country’s inflation rate which means that for interest rates around 14 percent-18 percent they are usually doing extremely well subject to exchange rate volatilities which may sometimes work in their favour e.g. when the naira strengthens and buys more dollars in the official market. For example, if someone brings in $1 million and exchanges for N360 in order to invest in our bond markets, that is N360,000,000. If the naira appreciates to say N180 to the dollar at the end of that investment, the principal amount will fetch an investor a clean $2 million besides interest or profit.

This group of investors is also aware that a country with high inflation rate struggles to reduce such a rate. Inflation is known as a nation’s worst enemy because it generally eats away at everybody’s resources (even though it may not be as directly applicable in Nigeria as elsewhere for some reasons I will explain shortly). However, for the monetary authorities in a country to bring down inflation rate, they may have to increase interest rates. This attracts both foreign portfolio investments and domestic savings, thereby strengthening the local currency. The only problem will be where inflation is not managed and causes an economic crisis, leading to a currency devaluation. Then foreign investors – whether portfolio or direct – have cause to fret.

Nigerian banks insist that having sterilised a large proportion of their funds, they are desirous of making some positive real interest rate since they operate within Nigeria. Hence the high interest rates they charge on loans. The banks, however, negate themselves when they compete on profitability rather than stability. It is difficult to convince the world that you are struggling to make a margin on your ‘expensive’ deposits when you declare profits in the hundreds of billions, even in an economic recession. Our banks’ profitability rivals that of banks in other advanced economies but our economy is in doldrums. This is something the banks have to care about.

Meanwhile, let’s hear the perspective of our local banks:

The Perspective from the Banks – The Nigerian Angle

The banks have complained of sterilising too much of their deposits in statutory reserves. They also complain of other expenses like the NDIC premium paid as insurance for depositors. They seem to have moved on from complaining about generating sets and diesel, and we can see the effect of artificial intelligence in the banking sector whereby many have been laid off, replaced by e-banking, and ATMs. The Central Bank of Nigeria as the regulatory body has set the statutory reserves at the level where it is presently, based on past experience with bank failures. On that issue, the banks can only continue to negotiate with the regulator. I particularly support the sterilisation of public sector funds because the previous arrangement led to too much profiteering on the part of top public sector executives and bankers. That regime also saw the deliberate sub-optimisation of public sector funds, which are often held in fixed deposit accounts, while projects remain abandoned.

So with personnel costs shrinking as a result of layoffs, and a number of branch closures happening due to a very shrewd era of new rationalisations, what excuses do the banks retain for their high interest rates? To make matters worse, a handful of banks seem to be having an effervescent business cycle with huge profits being declared yearly, even as the rest of the economy is comatose – especially the SME sector. We have also seen many high-profile cases of bad bank credits like Etisalat, and many others, that get people thinking whether the banks deliberately shunt the due diligence processes of cross-checking credit-worthiness at Credit Bureaus or whether there is unholy collusion between bank workers, management and their heavily leveraged clients.

These are peculiar issues in Nigeria.

Looking into the future, it will be great for Nigeria to have a single-digit interest rate. But like in other things, we must not underachieve. We should not pursue single digit interest rate just because it sounds nice to have. We must start with the end in mind. Why do we want a single-digit interest rate? What do we want to achieve for the economy at large?


Which way forward?

The Central Bank governor, Mr. Godwin Emefiele, stated in March 2017 in reference to why interest rates are high in Nigeria that;

“It is also important to note that interest rates reflect both cost of capital, as well as cost of doing business. If we can approximate cost of capital as the average saving interest rate, which is about 6 percent, what then accounts for lending rates at 25 or more percent? It is cost of doing business. For example, a typical Nigerian bank must employ the services of policemen and other security people deployed constantly to protect its branches. The bank must also provide a significant amount for reliable electricity and broadband internet services to keep its systems running. These expenditures only further increase costs of doing business for lenders, a cost they must pass on to borrowers. This is why the CBN’s fight to bring inflation down is strongly connected to our quest to ensure that lending rates also come down in due course.”

Remember Senator Misau versus Nigerian Police? The World Bank Ease of Doing Business Report documents factors, such as ease of registering property, ease of obtaining credit, ease of liquidating a company, protection of minority interests, cross-border trading and so on, which do not have direct bearing on the business of banks here, not to talk of SMEs. In Nigeria, things like police protection, and the plethora of corruption that businesses face when they want anything done, are what racks up the cost of doing business.

Also, we need to consider the cost of doing business in a generally inefficient environment where standards are disregarded and there is no commitment to service excellence. We all have a great work on our hands to ensure that Nigeria gets to the level where other progressive countries are – a point where everybody does his/her job perfectly without any prodding or financial inducement. For now, that is not the case and the banks – just like other businesses in Nigeria – bear the cost of systemic inefficiencies, thereby necessitating high interest rates. There is a need for us to work on our culture as a people.

How Crucial Is Low Interest Rates In An Economy?

Another argument surrounds the relevance of interest rates to the growth and prosperity of the Nigerian economy. Is it true that high interest rates is the major problem with Nigeria? Some people believe so.

But I personally think not. With huge infrastructural deficit, many loans are spent not on growing businesses but on providing infrastructure. Ultimately, since our competition is not from among ourselves but with the rest of the globalized world, any loan spent providing infrastructure that is taken for granted elsewhere puts our entrepreneurs at disadvantage and increases their cost of production. Since they cannot be protected for long by the Nigerian government, there comes a time when such businesses are left to the vagaries of the international market and they either shrink, or die because they are not made for global markets. In an uber-competitive globalized marketplace, there is no way such companies can cope.

Therefore the first step to global competition is responsible governance and the provision of the needed amenities and infrastructure. A low interest rate or cheap bank credit cannot fill in that space. We have to be strategic.

The Long-Term View

Looking into the future, it will be great for Nigeria to have a single-digit interest rate. But like in other things, we must not underachieve. We should not pursue single digit interest rate just because it sounds nice to have. We must start with the end in mind. Why do we want a single-digit interest rate? What do we want to achieve for the economy at large?

It is at this point we need to determine where the Nigerian economy is in the scheme of nations. Now is the time to ask critical questions: If matured economies are parading interest rates of 2 percent per annum, can Nigeria follow suit and of what effect will that be? Should we model after these matured economies where interest rate is tending towards negative? What is our perspective on economic growth? Nigeria has just exited recession with a fragile GDP growth of 0.55 percent. We are ecstatic about the prospects of a 2.3 percent growth by the end of next year as predicted by IMF. Is that the type of growth we should be pursuing at this stage of our economic development? That is slow growth, which in my view is okay for plateauing economies. We should be doing double-digit GDP growth by every means. Some economists have argued that at our stage of development, we should take the risk of having higher inflation levels so long as the economy is productive and growing in leaps and bounds. These economists also believe that for us, a double-digit interest rate is not such a bad idea as the regulator tries to tame inflation. In short, our economy is a different type of animal compared with the matured economies. What matters most is the destination we are heading. Are we funding industries, and productive ideas? Or are we funding ostentation, and runaway fiscal irresponsibility?

Again, what should the naira’s exchange rate be vis-à-vis the US dollar given our economic complexity and the productivity of the US economy comparatively? I mean, what do we produce – crude oil in the main, and a few raw agricultural products? But what does the US produce? The highest levels of technology, softwares and hardwares, knowledge, Hollywood, innovations from Silicon Valley, arms, ammunition, bombs and what have you. And it is the most diversified economy on earth because American citizens are perhaps the most self-sufficient on earth. There is nothing they need that an American company somewhere within the USA does not produce.

Nigerian banks should tinker with their business models and develop a new ethos such that they stop competing on the basis of profits declared. Reducing interest rates will surely have the implication of lower profit. With the present mindset of intense competition for huge profits, the banks are drawing the flak of the public and rightly so…


Side by side a nation that produces the highest levels of technology that runs the entire globe, from telecommunications to information and defence, perhaps the best we can do is manage our currency at a certain band just as we are doing today. I believe the first step towards making progress is for a people to determine where they are today in order to pick up the technology that may aid their advancement. This is the kind of mindset we may need around the subject of interest rates. We cannot afford to compare with developed countries for now, but let us be sure that we are doing the right thing with the time on our hands, and moving forward, not engaging in reverse.

What Can We Do to Crash Interest Rates?

The CBN has made clear that if it arbitrarily reduces interest rate levels for now, inflation may resurge. It may be arguable, because someone may posit that banks are just not willing to lend and they are not going to be falling over themselves to do so when interest rates fall, thereby invalidating the idea that excess liquidity in markets will lead to higher inflation. The banks seem to have developed minds of their own and only lend to their powerful friends, who promptly lose the money by transferring this abroad for all sorts of vanity projects.

So what can we do to get interest rates to fall at all, and what should we expect in time?

The fault is not in our stars but fairly distributed among several parties. I would suggest the following:

1. Nigerian banks should tinker with their business models and develop a new ethos such that they stop competing on the basis of profits declared. Reducing interest rates will surely have the implication of lower profit. With the present mindset of intense competition for huge profits, the banks are drawing the flak of the public and rightly so;

2. The CBN should continue to intensify its surveillance and supervision roles on the banks so as to prevent high occurrence of bad loans and its concomitant effect on the bank’s cost of business. Perhaps loan write-offs (Non-Performing Loans) are the biggest cost item in banks’ books these days. Some of the figures we hear are mind-boggling, even from those ‘first generation’ banks that we thought were well-run. And some of the scandals that become public show that some of the executives of our banks have still not got the memo that corporate governance standards must now be elevated. They are simply in cahoots and the corruption in the private sector rivals the public sector in Nigeria. We also hear the bank executives currently pay themselves obscene salaries and also collect huge payouts – sometimes in the billions – for throwing money away, when they retire;

3. Nigerians should be mindful of the psychology that justifies our penchant for making it big, which informs the doubling and tripling of prices and, by extension, constantly galloping inflation. For as long as the inflation is high, interest rates will continue to be high as the central bank will not risk bringing down interest rates only for inflation to run away. Let’s look at the psychology of a Nigerians on one hand and a Briton on another. If the price of motor fuel/gas suddenly rises – like it does sometimes in both countries – the Briton does not adjust the prices of his goods up by 50 percent, but the Nigerian does. Transportation costs in the UK does not spike, but in Nigeria it does. Why? So long as the few who produce in Nigeria are always trying to game the system for higher profits and our sense of moderation is not activated, for that long will inflation indices remain high, and the Central Bank will not be willing to reduce lest it climbs even further. It is the frivolous expenses we engage in, sometimes as part of our culture, that puts us under constant and immense pressure to get rich by all means. This is a key reason why interest rates are high here.

4. Bank borrowers must ensure that they repay also. At some point we managed to tame NPLs – non-performing loans – to about 2 percent of bank loan books in Nigeria, but of late it has become an issue all over again, to the extent that some economists are calling for AMCON 2. AMCON 1 is struggling to resolve the loans on its books. If economists are cavalierly justifying the plethora of bad loans that banks are creating, this will not encourage responsible behaviour on the part of bank managements, and the regulators will not further fuel the fire by reducing interest rates. Why do Nigerians delight in not repaying their credit? That is bad behaviour, especially on the part of the high and mighty in society. We hear stories of insider credit and director-related loans which leave a bitter taste in the mouth.

Everyone of us has responsibilities – to change our behaviour towards credit, and to understand our economy better, such as to moderate our expectations. The regulator must also constantly tool itself and step up its game, so as not to get the blame. Cheap credit is not the only panacea to the economy but a means to an end. From the above we have seen that we have much work to do in several departments in order to achieve our El Dorado.

Let me remind us though, that it is far better – and more reasonable and feasible – to achieve a 15 percent growth of the overall economy year on year, while living with double digit interest rates and double-digit inflation. That is what we should be targeting for now. There are too many sectors of the economy that can do a lot better but are being ignored today. Nigeria is not optimising the use of its youthful labour, for starters. When the young people of this country start to work, they will produce the growth we need, they will spend money, and they will attract tourist and investment funds from everywhere when crime drops. On that day we would have arrived.

‘Tope Fasua, an Economist, author, blogger and entrepreneur, can be reached through topsyfash@yahoo.com.