Last week a good friend asked me why I was not critical of the wide spread between the rates being paid to savers who deposit their cash with the bank and the rates being charged by the bank to those who borrow money. Glibly, I replied that as a shareholder one would be pleased with a wide spread as this is something which actually improves the bottom line. However, the vast majority of the population is not a shareholder in any of the commercial banks, a distortion in the market between saving and borrowing is bad news for them. When rates paid on deposits are low, savers are punished, and indeed with interest rates at present levels, the real value of a savings account is gradually decreasing all the time.
What this means to the average person is that at the end of the year their hard-earned savings can buy less than when they put the money in the bank. When lending rates are high growth in the economy is choked off because those who need capital to start new ventures are put off due to the prospect of foreclosure if they fail to keep up with prohibitive high lending rates.
Two measures of the relative difference between the cost of borrowing and the amounts paid to savers are the real rates and the spread or difference between the rates. The real savings rate and the real prime rate are the small savings account rate and the prime rate respectively, less the year-on-year increase in inflation as measured by the increase in the Georgetown urban consumer price index.
As the graph of real rates shows, the cost of borrowing as measured by prime has varied somewhat over the last ten years but current levels of around 10% seem to be fairly representative of the average of that period. The real savings rate however has declined steadily, though there was a recovery in the real rate in 1998 and 2001 corresponding to periods when inflation was less than 2% per annum.
What is not readily apparent from the graph of real rates is how much the spread has widened in the last few years. So, while the real cost of borrowing has not changed much, the difference between the rates paid to those saving and rates paid by those borrowing has increased sharply over the last ten years.
Source: Bank of Guyana
The question that must be asked is if the commercial banks are to blame for this? It is easy to point the finger at the commercial banks, since it could be argued that they can just increase the deposit rates. However this is not quite as easy as it first appears.
Banks serve a variety of functions in an economy. They provide a means of safekeeping for cash, which may or may not be important depending on circumstances. I would argue in Guyana, where there is a significant risk of robbery if large amounts of cash are not securely stored, people regard the safekeeping aspect of holding their funds in the bank most highly. Secondly, they provide a return to those who place money on deposit by way of interest paid in exchange for the bank utilising the funds. Given that deposits continue to increase in the banking sector unabated despite the negative real interest rates on offer one can assume that this is not as such a highly valued feature in Guyana as the security element. Third, banks increase the supply of money in the economy. If a bank lends out money that has been deposited, presumably that money will be spent on capital investment, goods and services. Some of that money may find its way into the hands of savers who will deposit that money back in the banking system. It is possible to build a very simple model of how much the banking system can (in theory) increase the money supply. Starting with a particular amount of deposits in the system and a maximum proportion of deposits which can be loaned out (which will be determined by liquidity and reserve requirements established by the central bank) if it is assumed all money loaned out finds its way back to depositors then the long-run equilibrium position where the maximum amount has been loaned out can be established. At this point it can be shown that the ratio of advances to deposits will be equal to the maximum proportion of deposits which can be loaned out.
By now, you may be asking what the point of all this is. The answer is that by comparing the actual proportion of loans to deposits with the theoretical long run equilibrium an estimate of the amount of loans the bank is making as a proportion of the amount it could be making can be built up. A greater proportion deposits loaned out means greater loan income and hence higher rates can be paid to depositors. So if more loans were made, even if some of that money finds its way back into the banking system it should benefit depositors with higher rates.
As the analysis shows, in theory banks could be lending out a lot more, the average liquidity requirement is 21% so in theory they could be lending out 79%. But there is a catch - most of the commercial banks have been burnt once due to loans which have gone bad. There is thus much more caution before lending out money. The problem is that situation is almost self-fulfilling. Lending large amounts indiscriminately opens the door to bad loans which then require costly write-offs leading to lending practices being tightened up and less being loaned out.
The banks all say there is a lack of bankable projects. Given the extremely high barriers to entry in the market in Guyana it is difficult for any new organisation to come and test this assertion through increased competition. There is also little competition through the direct issue of new debt and equity through the capital markets. To compound matters, more money continues to pile into savings and deposit accounts which the banks cannot really find a use for.
Commercial Banks Liquid Assets
Most of the liquid assets have been finding their way into Treasury bills - with a corresponding reduction in yields, and hence reduction in income to the bank and consequently the rates paid to depositors. Unfortunately, for the investor who relies on the bank as their only source of savings, this is all contriving to reduce their returns. Until savers start to "vote with their feet" and place their money in other types of investments or the amount being lent out goes up the situation will certainly continue. With the lack of alternative investment vehicles available locally this could have drastic consequences for the exchange rate if the obvious choice of substituting Guyana dollar accounts for US dollar accounts is made.