BoG prepares to announce new interest rate formula

By Elorm Desewu

Bank of Ghana, (BoG), the statutory regulator of the banking industry is working out to bring a new interest rate formula which would be transparent rather than simply looking at individual banks and their respective cost structures.

According to the governor of the BoG, Dr Ernest Addison “let us have a model that would be more transparent and can be easily monitored by everybody; by looking at a pool of interest rates that are common to the market— the policy rate, the 91- day Treasury Bill rate, the interbank money market rate – , and use some kind of weighting mechanism to derive an average base rate for banks, which would be common across the industry.”

He said the Bank of Ghana in consultation with the Ghana Association of Bankers has looked at the current formula and are bringing out a formula that would be more transparent instead of looking at individual banks and their respective cost structures.

“These are the agreements that the working committee has reached. So we expect that we will be able to, on a weekly basis or so, announce base rates, which will be a weighted average of market rates that we all know. And then, on the basis of that banks can establish the risk premium.

 So we have looked at it, and had some refinement done to the model. I think we may decide to put it out very soon. But I don’t think that you need the model, really, to get the banks to do the right thing because if banks want to keep interest rates where they are, they would provide the justifications on why they think that even though this is the base rate that is coming out of the model, this is their assessment of the risk premium associated with this or that” he said.

“ This is why we haven’t been that quick in pushing this movement to the new formula. Because, we want the banks to look at their operating costs and improve the efficiency of their operations. That is where the crux of the matter is. If we are able to have banks that are more efficient, irrespective of the model that is in place, you will see lending rates coming down; and this is why we are also pushing for larger banks so that we would derive the economies of scale from their operating cost environment, as a way of addressing the high lending rates in the economy” he explained. 

He therefore ruled out any possibility of capping of interest rate, saying “everybody, with the benefit of hindsight, can see the negative impact of putting into place interest rate ceilings. We already have a system where banks are determining their base rates on the basis of their operating cost and return on equity, and all types of other structural factors are considered in the computation”.

Empirical evidence supports the Governor’s position. Efforts in the past at capping lending rates have acted as a disincentive for the banks with regards to giving new loans, because they are dissatisfied with their returns on investment under the artificially lowered rates forced on them. This in turn has slowed, rather than increased the contributions of bank lending to economic activity and consequent economic growth.

As one economist succinctly puts it: “expensive credit is better than no credit at all.”