by Dr Hildebrand Shayo
Banks’ lending rates to business, and the effect on economic growth in Tanzania
The issue of banks in Tanzania being advised to reduce loaning interest rates is on the lips of politicians, government officials, the President herself, borrowers and loan seekers, whether small or large, seeking loans to run their businesses. Despite these efforts and calls, interest rates charged by lending institutions remain high, something that in-turn affects the growth of productive economic activities, business especially for SMEs and start-up businesses that offer employment on one hand but also tax base for government revenue. Why are interest rates not declining in Tanzanian market? Is the approach used to reduce rates wrong or inappropriate? Or is there a problem in the financial system and interest rates setting system in Tanzania? These are the issues that need reflection with an economic eye to assess why the situation remains the same despite countless calls to reduce the rates. This assessment described concludes with hints as to why it will be thought-provoking to bring down lending rates and what can be done.
Gain access to loans, interest rates and business lending setting panorama
As clamour to lower lending rates continues, Tanzanian borrowers, small or large should not expert reduced loans interest rates soon, notwithstanding lowered policy instrument rates and regular government officials’ reminders that include other strict measures issued by the Bank of Tanzania.
The conventional approach stems from the fact that interest is the return for the productive use of principal. Since physical capital is purchased with monetary funds, then, the rate of interest is taken to be the rate of return over capital invested in physical capital assets. Whereas the demand for investable capital draws from investment decisions of the business sector, the supply of capital results from supplies of savings derived from households. Loanable funds are the sums of money supplied and demanded at any time in the money market, where: funds available for lending are inclined by the savings of the people and the additions to the money supply (normally through credit creation by banks), while demand for loanable funds is determined by the need for investment plus desire for hoarding.
Within this theoretical background, although BOT practises different measures such as reducing statutory reserves money (SRM) lowering Repos, lending to banks, and reducing yields for debt instruments, these efforts have not yet translated into effective lowered lending rates as anticipated.
Actual lending rates remain at around 16% by most banks, except one bank that recently announced the reduction of rates for personal loans targeting farmers. This makes it harder for borrowers to access loans, and indeed the cost of finance makes it challenging to make profit.
High rates are good for the banks and their shareholders but damaging to viable economic activities that are vital for county’s economic growth. High banks rates also discourage prospective borrowers from applying loans, as others have opted to borrow from individual private lenders or family members.
Presently, there are some banks which lend up to 21% – four times of the BOT policy rate – while maximum mortgage lending rates in Tanzania is 19%. Digital lenders issuing loans through mobile money services, which are assumed to be cheaper due to lower operating costs, lend at a fixed cost between 11% and 15% of the loan among. This is repaid within a much shorter time period: up to a month. When annualised, rates charged by telecoms are a killer, though many users do not realise on how is expensive the loan through mobile phones can be.
Research on informal lending market finds loans at rates that are higher than mobile lenders or banks, as the cost of funds are ranging from 30% to 50% per month. Here risk of non-payment is the key driver.
The main drivers of high lending rates in Tanzania’s lending market are high operating costs, non-performing loans, and cost of funds. Interest income is the major earning stream for all banks.
Tanzanian banks’ operating costs are related to employee salaries and benefits, which account for an average of 44% of the banking industry operating costs and have been increasing over time. Folks familiar with banking industry supposes that maximum monthly salary of large bank CEO is TSh 60m (around USD $25,000), very roughly equivalent to a profit of a bank branch. Likewise, monthly pay for CEO of other medium and small bank ranges between TSh 15-30m.
The implications of these, is simple that efforts should be directed at improving operation efficiencies aiming at reducing banks operating costs. The key areas of attention are with respect to employees’ salaries and how to improve bank’s productivity.
Another notable cost that is not often taken seriously is the cost of premises and equipment – rent, transport fleet, equipment and utilities – which together constitute another 16% of the banking industry operating costs. In this case, ICT advancement in the country in service provision could bring these costs down somewhat.
As far as non-performing loans (NPLs) are concerned, this has become a major problem for most banks. Factors affecting NPLs comprise global financial crises, credit screening weakness, a decrease in supply of loans partly, and capital enhancement measures. In Tanzania, banks are aiming to comply with the regulator’s benchmark of at most 5% of NPLs. Some banks have gone beyond this figure due to various genuine reasons, including economic uncertainty and instability of the labour market, as well as unethical practices among loan officers. Each of these drivers nonetheless are subject to discussion as each might have its own story.
Cost of funds is another factor that keeps banks’ lending rates high, banks cannot lend money at lower rates than they themselves pay. According to BOT, in Tanzania, the overall interbank cash rates which banks uses to lend each other, up to the period of seven-day ranges between 4.4% to 4.5% while overnight was at 3.72%. Here, some banks that have good relationship with each other usually outsource expensive funds outside the country when there is liquidity shortage locally and vice versa.
Regulator’s role and financial market dynamism in Tanzania
In recent years, the BOT has announced various policy measures to ease lending rules which include lowering the statutory minimum reserves requirement, lowering the discount rates as well as providing regulatory flexibility on restructuring of loans. For instance, in 2021, the central bank lowered its benchmark lending rates from 7% to 5% to cushion banks from Covid-19 impact. This together with the policy change aimed at to provide additional space for bank to borrow at a lower cost, hopes to encourage lower rates by banks. To spur liquidity, the regulator correspondingly resolved to lower statutory minimum reserve to 6% from 7% effective June 8, 2021.
Various initiatives as stated in this analysis are now being practiced by various financiers including commercial banks. Initiatives such as cluster marketing where employees of the government established parastatals and corporate establishment are able to enjoy good, lowered lending rates may inspire many to get loans at costs that are low compared to what banks charges, but for how long? These tactics exclude important economic groups such as traders, farmers and businesspeople. And importantly they do not target help at start-ups and SMEs viewed as riskier prospects, though these could benefit from lower rates.
Attempts examined in this article to help deal with high lending rates alone on the other hand will not bear fruits without political will. As such, top government officials, including President Samia Suluhu Hassan on various occasions, have made an appeal to the banks to rethink and consider lowering lending rates telling them that they are part of the wider economy. Likewise other leaders also have from time to time have been calling for banks to reduce lending rate, but this is unworkable in real sense.
The implications of the analysis expressed in this article are that high interest rates signal banking sector inefficiency, and when that occurs it hampers not only financial development but also economic growth and potential productivity enhancement.
In June 2021, the President said, “financial institutions need to cut real interest rates in line with measures implemented by the BOT,” and suggested that rates for short term loans should be lowered to below 10%. Will banks in Tanzania heed the President’s call, or will they turn a deaf ear?
Hildebrand Shayo, BA (hons) MA, PhD, is currently a manager, responsible for Economic Research and Planning at TIB-DFI Development Bank, wholly 100% owned by the Government of Tanzania. TIB development bank is one of development financial institution responsible for financing long-term infrastructure and development projects with development impact.