Whose interest rates?

August 12, 2006 Recently, the Central Bank of Nigeria removed the cap on the interest rates allowing them to move in any market led direction independent of the Minimum Rediscount Rates (MRR). In some respect, it is probably correct to say that nothing has changed as the rates had always reacted to the dynamics of the underground economy even in the face of government attempt to control the direction. The key determinant of the direction in the movement of the interest rates had been the statutory allocation by the Federal Government . Once the system was awash with cash, the rates would automatically revise downward and those who ordinarily should put their money in the banking system would naturally look elsewhere for better returns. On the assets side, banks would naturally adjust the rates at which they give out loan depending on the demand and supply for money with some inbuilt creative mechanism for appropriating the elements of risks involved in the transactions. The lesson here is that complete regulation of the macro economic indicators has never worked anywhere as the law of demand and supply would always come into play. All attempts to regulate the interest rates and exchange rates in Nigeria in the past had recorded little success. The more the government attempted to regulate the exchange rate of the naira in the official market, the more the gap between the rates in that market and those obtainable in the parallel market continued to widen. And when government decided to fix the rates at which the banks should lend money out , the banks had always found a way around it by loading the transactions with so many charges such that the cost of sourcing such fund was as expensive as it would have been in a deregulated environment. There are thus enough reasons to state that there is logic in the measured deregulation of the interest rates as announced by the CBN. To some extent the economy has continued to witness some level of stability even though we had continued to see some ‘unseen hands’ at play the exchange rate of the naira has remained fairly stable and banks have been able to predict transaction rates among themselves. It goes without saying that when there is stability in the system, it makes planning a bit easy. The official removal of the cap on the interest rates brings with it some positive signals and possibilities that need to be highlighted. There would now be an unfettered opportunity for banks to create different lending options prominent among which will be the introduction of the floating rates regime. It should be possible for banks to lend money to low risked companies which should self adjust depending on the level of perceived risk. This also means that fundamentally sound companies should be able to access cheap fund in the market to enable them beef up their operations and when more companies can readily access funding for their operations, it should bring a domino effect on the economy. The second advantage of the decision to remove the cap is that it would encourage healthy competition among the banks on the assets side of the balance sheet. This can only be good news for users of bank funds as they will be open to options in accessing finance and this is where the power of negotiation comes in. Again the new policy will free the CBN from spending a large chunk of its time in monitoring the activities of the banks which are in most cases lending above MRR. It ought to be spending time and resources on developing the IT capacity and human resources skills of its personnel for effective delivery of its assorted services. And of course the overnight consultants who make money by harassing banks which gives out money above the stipulated band won’t have a job to boot. Largely regulation of any type brings distortion and makes it impossible for efficient system to exist. We encourage the regulatory agency to pay attention to the development in the new measure to enable us assess its impact on the overall economy.
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