Ammon News - By Yusuf Mansur

American poet Robert Frost once said: "A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain."

This, with all the obvious sarcasm, could have easily been said of the banking industry in Jordan and its behaviour during 2007-2010.

The average interest rate on a loan to a bank’s prime (best) customer in 2007 was 8.15 per cent. In 2010, the rate became 8.2 per cent, which means that it increased slightly. Note that this is an average; bank-lending rates may vary around this rate, but as a national average, the rate charged by banks increased on loans after the collapse of the Lehman Brothers in September 2008.

Meanwhile, if one were to deposit his money at a bank in 2010, one would have received an average return (interest rate on deposits) of 5.5 per cent. This is the rate that banks pay for using one’s money to lend to others. This interest rate on deposits dropped to 3.3 per cent in 2010. In other words, the private banks, which were making in 2007 a margin (difference between what they paid to depositors for using their money and what they received from lending this money to borrowers) of 2.65 per cent, are low making 4.9 per cent, almost double what they made three years ago.

And this is not all. Not all deposits at banks make the same rate. If one deposits one’s money at a bank as a demand deposit, one is more likely not to make any interest income on this money.

At least 26 per cent of deposits are demand deposits, which earn a rate of interest of 0.9 per cent on average. This money is then lent to borrowers at 8.2 per cent, which is a huge margin and makes the cost of money to banks not 3.3 per cent but 2.9 per cent, which is the effective interest they pay on all deposits. The banks’ margin is, therefore, close to 5.3 per cent, which is what the banks make in 2010, instead of the 2.65 per cent they were making in 2007; not a bad haul for any bank anywhere.

In response to the spread of fear of the global financial crisis, the Central Bank of Jordan lowered the required reserves rate (portion of deposits placed with the Central Bank that cannot be lent) from 10 per cent in 2007 to 7 per cent in 2010. This meant that banks could lend more of their deposits than before and make more money by lending additional funds at double the old margin.

But this is not the only freebee they received. The discount rate (the rate at which banks borrow from the Central Bank) was lowered from 7 per cent in 2007 to 4.25 per cent. In other words, they could have lent even more money at a lower rate, making an even higher margin. Furthermore, the new income tax law lowered taxes on banks.

Why? To give them a break, I guess.

The private banks did not listen to the Central Bank of Jordan, which lowered the discount rate as a signal to banks to lower their rates. The banks neither lowered their interest rates nor increased lending to the private sector. They decreased lending in 2009 and opted to lend to the government. It was only recently and under the current Cabinet that the government refused to borrow from banks at the high rates of 7 per cent, as the previous Cabinet did.

Is it not fair to ask why the private banks did not listen to the regulator, the Central Bank?

Better still, why didn’t the Central Bank apply Article 43 of its law, which states: “the Central Bank may issue to the licensed banks and the specialised credit institutions orders published in the Official Gazette and through other media of public information prescribing the following: (a) The minimum and maximum interest rates which the licensed banks and the specialised credit institutions charge on credit facilities which they extend to their clients, irrespective of the provisions of any other legislation or regulation concerning interest or profit-sharing; (b) the maximum and minimum commissions which the licensed banks charge on credit facilities, and the administration of accounts and other services offered to their clients; (c) the minimum and maximum interest rates which the licensed banks and the specialised credit institutions pay on deposits with them.”

The regulator being so empowered by this article, why were banks allowed to act so freely?

If one desires to fix the economy and get it out of the current slump, the monetary policy has to be fixed first.

It sounds simple, but so is our economy.

ymansur@enconsult.com


* Jordan Times