Interest rates are one of the most crucial things to watch out for whenever you want to borrow some money especially from a bank.
However, very few people take time to understand what the interest rate is take for instance when applying for a loan.
An interest rate is either the cost of borrowing money or the reward for saving it which is calculated as a percentage of the amount borrowed or saved.
This means that banks borrow money from you in form of deposits, and interest is what they pay you for the use of the money deposited.
However, banks charge borrowers a slightly higher interest rate than they pay depositors.
Although interest rates are very competitive, they vary from one bank to another. A bank will charge higher interest rates if it thinks there is a lower chance the debt will get repaid.
Cutting interest rates
Recently, it has been a trend by commercial banks to cut interest rates. Whereas financial analysts refer to it as a ‘targeted campaign’, the big question is: Why the sudden move and appetite by almost all banks to reduce their lending rate during this time?
For instance, Stanbic bank Uganda, promised its customers that they will be in position to get loans from the bank at 15.9 per cent for at least three months until May to finance their various business activities among which are health establishments, education.
Pricing of low loans
Mr Jackson Emanzi, head of lending products, Stanbic bank noted that the pricing of low loans is to encourage potential borrowers with urgent cash needs to approach the bank for relief.
“These loans are a crucial financial service that can help boost businesses and enhance the speedy recovery of the economy,” Mr Emanzi said.
Dr Adam Mugume, the executive director research, Bank of Uganda (BoU) notes that there are several factors under play that are leading to the appetite by banks to lend.
“First, demand for credit is gradually picking up. For instance, value of new loan applications was Shs994 billion in June 2020 and it has edged to average of about Shs1.4 trillion per month in the last five months,” Dr Mugume says.
Second, yields on government securities, which are risk free rates, have come done. For example, the yield on the 364-day T-bill has come done from highs of 13.8 per cent in Jan 2021 to 11.7 per cent in March 2021.
“Therefore, with lending interest rates averaging 18 percent in the 3 months to January, lending to private sector becomes attractive since it gives a good return after accounting for possible defaults,” he explains.
Third, increasingly as the economy gradually picks up after bottoming up in the last quarter of 2020, risk aversiveness is somewhat declining, and this is stimulating credit expansion.
Dr Mugume adds: “The credit extension has been on a gradual increase not sudden. At an annual growth rate of 10 per cent in February 2021, rising from 6.8 per cent in August 2020 is not a sharp increase. Annual growth of credit extension was in the range 12-15 per cent before Covid-19.”
Why the drive?
Ms Patricia Amito, head communications and corporate affairs at the Uganda Bankers Association (UBA), says the demand for credit drives lending.
“Many sectors have been impacted by Covid-19 in various ways. Some businesses have unfortunately closed, others have had to reduce their operating costs, while other customers are venturing into other business opportunities,” Ms Amito says.
She notes that the Standard Financial Information Structure (SFIS) have also lowered lending rates in an effort to support the private sector recover from the effects of the pandemic.
“Banks have been sitting on plenty of liquidity for more than 12 months because of lock down and the fact that business activity was slow,” she concurs.
However, with lifting of lock down in most geographical locations including Uganda, supply chains have opened up, businesses are beginning to pick up and demand for credit is growing.
She adds that the Treasury Bill rates lowering as a monetary policy tool encourages banks to instead avail more credit to private sector to stimulate economic activity and recovery.
Mr Guy Lutaaya, Head of Credit, Absa Bank Uganda, says, these are targeted lending campaigns by banks where the sweetener includes a reduction in interest rates for customers taking up new or additional credit facilities during the campaign period.
“Most of the lending campaigns that we are seeing being rolled out by banks are targeted to individual borrowers, mostly salaried customers. This is a segment where banks feel most comfortable to push lending in this environment,” Mr Lutaaya says.
Given the stressed business environment coming out of 2020 and the fact that a sizeable part of businesses were under the Credit relief measures – the businesses themselves are watching the economic recovery before making major lending decisions; and also Banks are cautious in advancing credit in such uncertain economic conditions for businesses.
He explains that as long as we see government’s appetite to borrow continues to finance the government deficit,banks would look favourably to government paper that yield a risk-free return rather than lending to the private sector where a default risk premium is attached.
“This crowding out effect means that the lower interest rates being passed onto the private sector will only happen if the Banks max out their Sovereign lending limits, given the returns on Government securities,” he says.
Mr Godwin Juma, financial advisor, says that due to the impact of Covid-19, the Central Bank sought out to solve liquidity problems.
He notes that this problem can be solved by banks increasing their appetite to lend which is also part of the business move.
“The banks can only survive by lending either to people, individuals, companies or government. There are also shareholders who are interested in making money,” Mr Juma says.