Download impact of capping of interest rates

IMPACT OF CAPPING
OF INTEREST RATES:
LESSONS FROM ACADEMIA
INTRODUCTION
• interest rates caps are necessary in ensuring financial
support for crucial sectors of the economy where market
forces fail and where young industries cannot afford
commercial credit at prevailing rates
INTRODUCTION
• interest rate caps can be used to protect consumers from
exploitation by guaranteeing access to credit at
reasonable rates
INTRODUCTION
 it has been argued out that because the prices charged
for access to credit can be erratic and anticompetitive
and therefore be higher than the true cost of lending,
setting a lower cap on interest rates will provide an
excellent environment for lenders to operate.
• Lessons from academia: On MFIs
• Lend to small borrowers who require money for a variety reasons
such as consumption and financing of a business and who cannot
afford credit from the commercial banks. Interest rates will be high
leading to high economic profits.
Lessons from academia: On MFIs
• - More employment (usually of graduates) to serve the many
borrowers
- More borrowing for those who need to further their
education
- More funding to small businesses leading to growth
innovation, invention and entrepreneurship
Lessons from academia: On Banks
• When the interest is capped the banks are likely to face two main risks:
• Adverse selection as the demand for credit increases, they will not be able
to differentiate to between higher risk and lower risk borrowers. The
banks therefore charge an aggregated rate which is more attractive to the
higher risk borrowers leading to high risk of default.
• Moral hazard: When an investor borrows at a high rate they may make
riskier investments in order to cover their borrowing costs leading to high
risk of default.
Lessons from academia: On Banks
When interest rates are capped at very low levels,
banks reduce the level of lending, increase
processing costs, and introduce new products
-Retrenchment of staff
•
- banks reduce the level of lending to those
who would want to further their education
Lessons from academia: On Banks
•
- On the Supply of loans to Educational institutions may
increase as they may have necessary collateral
- banks may reduce funding of research due to reduced
profitability.
•
Lessons from academia: On Banks
- High growth of black market as borrowers look
for quick monies leading to market distortion
- Low deposit levels as the banks do not want to
hold excess funds they cannot lend out. This
leads to failure of understanding of the linkage
between policy setting and practice
Lessons from academia: On Banks
- NPLs go up which may lead to bankruptcy. This will require a
lot of learnings around policy making and risk
(measurements & impact) modelling
Lessons from academia: On Banks
- Investments in terms of deposits may go up especially
where the return is higher than those offered by alternative
investments in the market.
- The constrained credit product mix in price capped markets
leads borrowers to use products which are less suited to
their needs and expose them to greater risk
Lessons from academia: On economic
growth
Reduced profitability of banks coupled with low lending
levels do not stimulate investment and business growth and
hence economic growth.
- Policy intentions must be clearly evaluated as they can lead
to contrary results from expectations
Lessons from academia: On stock markets
• When rates are capped at levels that can provide investors with a
moderate sure return on investment, they will shift their
investments to the banks as deposits other than investing in stock
markets.
• Stock markets may not be the best proxy to measuring economic
outlook of a country.
Lessons from academia: On Investments
• Capping of rates may stimulate investments when properly done but
it may also discourage investments when proper thought has not
gone into the decision to cap.
Lessons from academia: On Employment
• May go up or down.
• Thank you