Editorial | Why interest rates remain high

Recently, there has been an outcry from Jamaica’s business community over the slow response of commercial banks to policy rate by the central bank.

For while the Bank of Jamaica (BOJ) has taken decisive steps on this front – it lowered its policy rate four times during 2024 to 6.25 per cent – hoping to stimulate the island’s lagging economy, which declined 3.5 per cent in the third quarter and was on track for a further downward movement – the expected reduction in lending rates has lagged. Average commercial bank lending rate moved from 11.6 per cent in 2023 to approximately 10 per cent in 2024.

The result is frustrated businesses, and, as most people see it, the undermining of the intended benefits of monetary easing.

The upshot: there has been more pressure on the central bank to go further and deeper with its cuts.

Indeed, in a year-end joint statement by the island’s business groups – Private Sector Organisation of Jamaica, Jamaica Manufacturers and Exporters Association and Jamaica Chamber of Commerce – “strongly urging the BOJ to continue lowering the policy interest rate to further stimulate the economy”.

They also called on the commercial banks to “immediately reflect the rate reduction in their lending practices”.

The slow, halting downward movement of the rates charged by banks highlights deeper structural and institutional challenges that must be addressed for monetary policy to work effectively.

RELIES ON POLICY RATE

The BOJ, like all central banks, relies on the policy rate as a key tool to influence borrowing costs, investment, and consumption. However, in Jamaica, the transmission mechanism between the policy rate and commercial lending rates has been sluggish, due to three fundamental issues.

First, Jamaica’s banking sector is highly concentrated, with a few dominant players controlling most of the market. This weak competitive environment gives banks little incentive to adjust lending rates promptly, as businesses and consumers have limited alternatives.

Second, banks in Jamaica face significant structural costs, including high operational and compliance expenses, which they often pass on to borrowers.

The third factor is the perception of high credit risk in the local economy which discourages banks from lowering rates, even when the central bank signals that borrowing should be cheaper. Also, many borrowers and savers in Jamaica are slow to renegotiate terms or move their business elsewhere in response to rate changes, reducing the competitive pressure on banks to adjust their offerings.

In addition to the policy rate, the Bank of Jamaica uses other methods to influence the cost of short-term borrowing and guide market expectations. It, for instance, employs liquidity management tools, such as open market operations, to ensure adequate liquidity in the banking system.

However, these tools rely on the assumption that banks will adjust their lending and deposit rates in response to changes in funding costs.

DOES NOT HOLD

Unfortunately, in Jamaica, this assumption often does not hold as expected. The BOJ has limited direct control over the rates charged by commercial banks, which are determined by a combination of market forces, operational costs, and risk assessments.

The joint private sector press release also asked the Bank of Jamaica to meet urgently to “address the inefficiencies in the monetary transmission mechanism”.

To bridge the gap between policy intentions and market outcomes, it would be of immense value if the agenda of the discussions between Bank of Jamaica and Jamaica Bankers Association took a multi-pronged approach to covering a wide range of issues that borrowers face.

These should include:

. Measures to encourage the entry of new financial players – including fintech companies – to challenge the dominance of established banks;

. Measures to strengthen microfinance institutions;

. Ways of increase the availability of variable-rate loans, which could be adjusted more quickly to changes in the policy rate;

. Educating borrowers about the benefits of variable-rate financing to drive demand for these products;

. Foster greater financial literacy to help borrowers understand their options and demand better terms from lenders; and

. Strengthening consumer protection laws and practices to ensure transparency in lending practices.

CLOSING GAP FOR ECONOMIC GROWTH

The slow response of commercial banks to the BOJ’s policy rate cuts is a symptom of deeper inefficiencies in Jamaica’s financial system. Addressing these challenges will require bold reforms and a coordinated effort between the central bank, government, financial institutions, and the business community.

By fostering competition, reducing structural barriers, and promoting transparency, Jamaica can create a more dynamic financial sector where policy rate changes translate quickly into tangible benefits for businesses and households. The stakes are high, but with the right mix of policies, the BOJ can ensure that its efforts to stimulate the economy bear fruit – sooner rather than later.