Borrowers bear high overheads of banking oligopoly

Dennis Morrison, Contributor

Much sound and fury has been directed at the local banking sector for its resistance to cutting lending rates to fully reflect the reduction in interest rates orchestrated by the Government through the Jamaica Debt Exchange (JDX) programme and as the world is experiencing the lowest rates in nearly 60 years. The most pressing reason for lowering rates was to bring down the unsustainably high interest costs of the public sector. But it was expected that an equally important outcome would be a steep fall in the rates paid on loans that businesses need to finance their operations, a critical step if the economy is to take off.

Though it is acknowledged that there would be a period during which the banks would continue to pay interest at the previously higher contracted rates on investment deposits while receiving lower rates under the JDX, this gap should by now be substantially reduced. This means that lending rates should be coming down faster so they fall in line with the low interest rates now being paid to depositors. Not for the first time, the banks which operate as an oligopoly appear to be holding on to much of the benefit - as they have done since the Government liberalised interest rates in the 1990s and freed up banks to set rates.

In a market-economy system where companies compete to sell their goods and services they are forced to face certain realities when the economy goes bad and sales drop. They can drop their prices to try to boost sales and remain profitable if even at reduced levels. Or they cut costs and if the fall in sales is manageable, they could still end up making profits. These are the typical strategies adopted by merchants in mild recessions and off-peak shopping periods.

forced to adjust operations

Where market conditions are harsh, such as the current recession, the other option is to do a combination of cost-cutting and price reductions. And businesses in many instances are being forced to drop the profit levels they can expect to earn. This is how many in America have been operating since 2008. In going after cost savings, they put all items under the microscope - those they control directly such as overheads come under the greatest scrutiny. Competition in the marketplace forces them to adjust their operations to cope with changing realities. But Jamaica's banks, in our distorted markets, are run on a different basis.

In a shrinking economy where bank lending has been declining, one would have expected their profits to contract. Together with the sharp cut in their interest income under the JDX, this should have resulted in significant reductions in their profits. Yet, in these dire circumstances, recently published reports show National Commercial Bank recording increases in nominal terms, although below the rate of inflation. More realistically, Scotiabank (Jamaica) announced that its net income had slipped by over 11 per cent, still a moderate fall considering the environment. How were they able to generate these results? Was it by cost savings or increased lending or a combi-nation of the two?

Some cost cutting has been taking place but we have not been seeing the kind of consolidation of branches and other moves that would be in keeping with the economic downturn and JDX effect. We know, too, that bank loans have been on the decline, including by our largest banks. What then accounts for the ability of these banks to stave off the kind of fall in profits that the economic situation would lead us to expect? Part of this puzzle is not so difficult to solve.

big chunk of deposits

To understand how our largest banks make money, we must examine the drastic reduction in the interest rates they pay on passbook accounts. This is a big chunk of bank deposits belonging to unsophisticated customers and dominated by the big two traditional banks. While the rates paid on these accounts were up to 15 per cent in the mid-1990s, the banks had dropped them to well below 10 per cent by the mid-2000s. In the aftermath of the JDX, the rates on passbook accounts have been cut to as low as 2.0 per cent.

Herein lies one solution to the puzzle. By paying meagre interest on monies in these accounts which they then lend at high rates to businesses and consumers, the banks reap wide spreads that give them a source of substantial earnings to boost their profits. So the holders of passbook accounts have been easy pickings and are involuntarily cushioning the negative impact of the JDX on the banks.

The push to pull in more income from fees has been more obvious but the banks have really been generating their profits from the wide interest rate spreads since the Bank of Jamaica stopped regulating rates. They did so aggressively during the period of high rates in the 1990s and as rates fell in the 2000s. They are continuing to do so now with the advent of low rates and as the local economy remains in recession. The basic truth is that borrowers and the economy, in general, are being asked to bear the cost of the high overheads of the banking sector and their determination to rely on wide interest spreads to boost profits.

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.