HOUSE TEAM FAULTS BANKS HIGH RATES.

The CITIZEN of 06th June 2014 on page 4, decorated with the above heading. The newspaper reporter (with slight editorial changes made by me in brackets) wrote: "High interest rates that local commercial banks impose on borrowers were yesterday blamed (on) the central bank's move to increase Treasury Bill rates. The Parliamentary Committee on Economy, Industry and Trade asked government through the Bank of Tanzania to consider decreasing Treasury Bill rate from 12.58 per cent to 7.58 per cent. The committee said regular fluctuation of (foreign) exchange, inflation and interest rates affected the running of local commercial banks negatively. The committee chairman, Mr. Luhaga Mpina said when tabling a report on 2014/2015 budget estimates of the Finance ministry that the treasury bill rates rise compelled banks to lend at exorbitant interest rates, leading borrower to default on loans."

BANKS HAVE DEFENDERS, BANK'S CUSTOMERS HAVE TO PICK THEIRS.

The perspective in which Parliamentary Committee on Economy, Industry and Trade chairman argues it is clear that he speaks to protect the interest of banks which are faced with potential losses from defaulting customers. Defending commecial banks high interest rates on Treasury Bills rates as if TB rates are compulsory benchmark for pricing of loans to customers from the law/regulator (the fact is: it matter of each bank credit and investment policy)was uncalled for and misleading. Even pension funds are not required by their respective Acts to place their funds based on the TB rates plus something if they are to deposit on fixed terms to banking institutions but it is an internal policy matter. If so happens, it would have been argued that since banks get large portion of funds (deposits) at high interest rate from pension funds then it is logical for the committee to request BOT to decrease the TB rates. Unfortunately, this is not or not always the case, because majority of bank's sources of funds (deposits) are saving and current account holders where by banks pays less than 7.58% interest rates on saving and nothing on majority of their current accounts.

The reasons as to why banks charge higher interest rates beyond Treasury bills rates are two fold; one is the opportunity cost concept and second the greedy nature of our bankers to get high pay and bonuses every year because of massive profits they generate. On the opportunity cost, no banker will opt to lend to customers and take percentage of credit risk at lower rate and leave Treasury Bills with almost zero credit risk and high interest rate returns. In order to balance return versus risk,the only option is to lend to customer at TB rate plus something to cover for the credit risk posed by customers. On the greedy nature, banker's are pressurized to maximize profits for shareholders and secure their jobs so they have to make more money each quarter and each year.

As a matter of facts, majority of banks are not affected by exchange, inflation and TB interest rates. For example, out of 30 banks, only 3 banks made loss on foreign exchange trading in the forth quarter 2013 most likely due to mismanagement, where as banks like CRDB, NMB, STANBIC, NBC, CITIBANK, EXIM made billions. On the cost of funds, in the same quarter of 2013, NMB cost of funds (interest expenses-TZS 6.7 Billion) was only 7% of interest income (TZS 97.6 Billion); on profit side, out of 30 banks, only 8 banks made losses because some are at an infancy stage of operations while others due to mismanagement or strategic risks. The rest made profits in billions and millions(the highest being NMB TZS 36 billion the lowest being BARCLAYS TZS 117 Millions).

Bank customers are not defended by words nor by practice by the committee from the greedy nature of our bankers in their pursuit of making massive profits at the expense of customers but rather carry the blame of defaulting! And so it goes, banks will be bailed out when they fail while customer's might get high tax on their hard earn money to pay for the banks!

DEFAULTING BECAUSE OF HIGH INTEREST RATES-MYTH OR REALITY?

Theoretically, it can easily make sense to claim that due to high interest rates, customers are defaulting. Hardly, can any serious banker prove this except on isolated cases. On reality, bankers and researchers know customer dont take loans because of interest rates or high interest rates rather than defaulting just because of it. There are numerous reasons including but not limited to bankers mistakes on evaluating customers and businesses for credit as a result money end up to incredible customers, bankers negligence to execute proper customer monitoring strategies leading into diversion of funds by customers as well as over lending and underlending to customers, customers low or absence of money and debt management skills just to mention a few.

Having said that, i dont rule out completely the possible negative relatioship between interest rate and loan repayment.There is a relationship, however, the reason is not just high interest rate but it is compounded interest rate and the way it is computed by employing actuarial method and collected on interest first and principal next. On compound interest rate former President of Nigeria, Obasanjo said, "All that we had borrowed up to 1985 or 1986 was around $5bln and we have paid about $16billion yet we are still being told that we owe about $28 bln. That $ 28 bln came about because of the injustice of the foreign creditors interest rates. If you ask me what is the worst thing in the world, I will say it is compound interest.” According to Professor Stephen G. Kellison author of a book titled The Theory of Interest, the word compound refers to the process of interest being reinvested to earn additional interest. With compound interest, the total of investment of principal and interest earned to date is kept invested at all times. For example, consider an investment of $ 100 for two years at 10% interest rate. Under simple interest, the investor will receive $ 10 at end of each of the two years totaling $20 in interest. Those against simple interest argues that is not a fair return to investor. Why? Because in reality at the beginning of the second year the investor has $110 which could have been invested at 10%. To solve this problem, compound interest assume the interest earned is automaticall reinvested. Using our example in the second year amount invested is $110 at 10%, since the investor would then receive $ 11 in interest for the second year totaling $21 in interest instead of $20 under simple interest.

Prof. Kellison says the actuarial method is defined on the basis compatible with compound interest theory. This method subdivide payments between principal and interest which is consitent with the widely used loan amortization schedule but inconsistent with what is known as United States Rule. Under U.S rule, payments by borrower should first be applied to pay any accrued interest, with any excess being applied to reduce the outstanding loan balance. If the payment fall short of interest the balance of interest is not to be added to the principal so as to produce interest. However, under actuarial method, which is consitent with compound interest theory, any such deficiency must be capitalized, i.e. added to the outstanding loan balance to accrue additional interest. Hence, the way compound interest rate works in addition to above mentioned reasons, customer forced to default.

Finally, Treasury Bills as a tool of monetary policy is not the only to blame, but compound interest mechanism, bankers, policy makers and members of parliament who are making financial and banking laws just to mention a few. Our members of parliament, key government economists, central bank officials and policy makers should devote time to learn what is in stock from Islamic Banking and Finance to protect our people and economy from maliase of compound interest mechanism. Hereby, worthy to quote Mr. James Robertson, author of Future Wealth:A New Economics for the 21st Century, “The pervasive role of interest in the economic system results in the systematic transfer of money from those who have less to those who have more. Again, this transfer of resources from poor to rich has been made shockingly clear by the Third World debt crisis..... When we look at the money system that way and when we begin to think about how it should be redesigned to carry out its functions fairly and efficiently as part of an enabling and conserving economy, the arguments for an interest-free, inflation-free money system for the twenty-first century seems to be very strong.”

Moreover, customers are not defaulting because of high interest rate per se but a combination of factors some are not expected to exists!