Interest rate capping debate rages

By Taonga Sabola:

Investment management and advisory firm, Alliance Capital Limited, says the debate on interest rate capping should not be dismissed outright on account of unintended consequences experienced in some countries.

In its 2018 Annual Economic Report, Alliance Capital says there is also evidence on the capping working in other countries.

The firm’s comment comes at a time Malawians continue to debate on whether to put a cap on interest rates as one way of making borrowing affordable for Malawians.

It also comes at a time the country’s interest rates remain relatively high as compared to many countries on the continent, despite last week’s slash.

International experience has shown that, if not properly implemented, interest rate capping can result in unintended consequences.

For instance experience in some countries has shown that interest rate capping has resulted in locking out small and medium enterprises (SMEs) and other high-risk borrowers from accessing credit as banks will prefer to loan to the government and invest in low risk Treasury bills and Treasury bonds.

Other unintended consequences include a withdrawal of banks from the poor or specific segments of the society, such as small borrowers, due to higher loan management costs; an increase in average loan size pointing to lower access by small borrowers and larger loans to more established firms

Capping has also resulted in reduced transparency such as an increase in the total cost of loans through additional fees and commissions; decreased diversity of products for low-income households; reduced banking competition and an increase in illegal lending.

But Alliance Capital argues that what is clear is that for Malawi, the decision as whether to cap or not to cap interest rates should be informed by evidence.

“The starting point would be for policy makers to use empirical studies to understand what exactly determines the rate borrowers end up paying.

“In other words, authorities should unpack what goes into the interest rate that lending institution charges (e.g. administration costs, risk allowance et cetera) and figure out what can be done to reduce them while maintaining the lending institutions efficiency and sustainability,” reads the report in part.

It adds that given that there is already evidence on what has worked and not worked from interest capping in other countries, Malawi could draw lessons from these countries and determine what would work best for the country.

“Malawi could also explore alternative measures to protect customers that have been employed in some countries such as setting up or enhancing the enforcement of financial consumer protection regulations,” Alliance Capital says.

Malawi Confederation of Chambers of Commerce and Industry Chief Executive Officer, Chancellor Kaferapanjira, said interest rate capping could not be the best solution to high interest rates in Malawi.

He said capping interest rates could end up choking SMEs rather than promoting them.

“We have always said interest rates are very high and they need to go down especially in an environment where inflation has ebbed. How that should happen is what is controversial. We believe that risk premiums, particularly those charges by commercial banks must go down.

“From a policy rate of 16 percent, how can average lending rate of 23 percent be justified? As a matter of fact the actual rate of lending is usually 33 percent plus up to 6 percent,” Kaferapanjira said.

He observed that MCCCI does not believe that pulling down interest rates should be done through a law.

Indigenous Businesses Association of Malawi President, Mike Mlombwa, whose institution was in the forefront of advocating for interest rate capping, said all indigenous businesses are looking for is an environment with affordable interest rates.

He said interest rates in Malawi have been too high for too long, thereby making borrowing for business to be unthinkable.

“For a long time, we have been saying that the high interest rates are hurting borrowers. That is why most of the businesses, which were there, say in the past 10 years, are gone.

“It does not mean that we have poor businessmen in Malawi but all their profits are chewed by banks in form of interest. So long as authorities find a lasting solution to the high interest rates, we would be happy. It pains us a lot to see many youths just loitering around in the streets looking for jobs and we can’t employ them because all our earnings are going towards interest payment,” Mlombwa said.

Interest rate capping is not a new phenomenon in Malawi. Until 1987, the Reserve Bank of Malawi (RBM) was setting a cap on interest rates and instruments were put in place to enforce it.

Since the 1980s, the country has undergone reforms, some of which were supported by the Breton Woods institutions, to liberalise the economy and make it a more open with no price controls and restrictions.

Specifically for the financial sector, in 1988, RBM stopped capping interest rates allowing commercial banks to set their own rates.