Tweet
Government's lack of fiscal discipline drove up interest rates — Bowen
Scotiabank's president and CEO Bruce Bowen provided participants in Mayberry's Monthly Investor Forum on Wednesday with a cursory glance at how interest rates are set in Jamaica. During the presentation, he hinted at the difference in how said rates are applied before and after the Jamaica Debt Exchange (JDX), a swap that saw the Government of Jamaica exchange its high interest earning instruments with those of lower yields and longer maturities.
One of the anticipated outcomes of the JDX was a significant reduction in interest rates as the rate on GOJ instruments were reduced. The JDX saw the interest payments move from as much as 23 per cent to a low of 12 per cent following its conclusion in February this year. The benchmark rates set by the Central Bank act as a floor for lending and investment rates.
"It represents the risk free rate and minimum return within a country," said Bowen.
Government's lack of fiscal discipline
In his presentation, Bowen suggested that the government's lack of fiscal discipline, which drove up rates and crowded out investors, was the main cause of high interest rates before the Jamaica Debt Exchange (JDX). However, after having suggested that there is stronger fiscal discipline as a result of the Stand-by arrangement with the International Monetary Fund (IMF), the often complained about still high rates were justified by the other factors contributing to their increase.
Among these factors is a four part formula that the banks use. That formula is a combination of the risk free rate, plus a premium for credit risk, a premium for operating costs and a premium for adequate returns to shareholders. All combine to determine the appropriate interest rate.
Little information on borrowers
But the formula gets a bit tricky. Bowen noted that because there is insufficient and inadequate information on borrowers, Jamaica's banks are faced with a task of trying to determine with such little information the credit risk of the borrower. This, he said would necessitate a higher credit risk premium than in countries where information on borrowers is accurate. Added to this is the relatively higher cost of collateral liquidation. In other words, in Jamaica the assets of the delinquent borrower are harder to dispose of when seized by the banks, hence the higher premiums paid by the borrower.
Jamaica's risk premium is also higher because of what Bowen describes as the economic volatility of the country and the increases in delinquency during recessions. He noted that Jamaica has been in a sustained period of recession for the past 15 years.
Loan delinquencies on the rise
To justify his point, Bowen pointed to the increase in non-performing loans and provisions for loan losses for commercial banks over three years beginning June 2008. Non-performing loan totals increased from 2.16 per cent in June 2008 to 5.59 per cent at June 2010. Provisions for loan losses also increased from 2.60 per cent in June 2008 to 4.42 per cent in June 2010. However Bowen did not indicate how the total amount of loans dispersed over the period had changed and how this may have impacted the level of delinquency shown.
Incurring operating costs
Banks incur operating costs to write the credit and administer the loan throughout the life of the loan, noted Bowen. Operating expenses typically represent over 50 per cent of revenues generated by the banks and inflation and contractual obligations can drive up these expenses over time, he said. Within the interest rate is a premium for these costs.
The final part of the formula is the appropriate return that is due to the shareholders and investors in the banks, including depositors. Bowen said that banks in Jamaica have to provide an "adequate risk adjusted return" to their shareholders.
"Jamaica's credit rating of B- requires higher risk adjusted returns," he added.
The risk premium argument was supported by comparisons with the credit rating of developed countries such as the US and Canada and developing country Trinidad, which have ratings of AAA, AAA and A respectively and the return on equity in local banks- another cause for contention- was compared with the ROE for banks such as JP Morgan, Citibank, Wells Fargo, RBC and Bank of America.
However, while there were favourable comparisons with the overseas banks, Bowen did not provide statistics about the performance of Jamaican banks, nor did he give any details of the cost reduction measures being taken that would cause more efficient operations.
Where's the beef?
He did not give any details of what the four components of the interest calculation were before the JDX and what they are now. For instance, if the banks were lending at 22 per cent with Treasury at 16 to 17 per cent, then what should be the calculations with Treasury at 8 per cent? Bowen did not explicate further into this issue.
And for those who make the argument that an interest rate reduction will lead to increased borrowing, more investment in productive activities, more employment and economic growth, Bowen had this to say: "Reductions in lending rates in an environment where business confidence is low has little impact."
The Jamaican experience has been paradoxical, Bowen pointed out, because GDP has not grown in line with the high investment rates seen in Jamaica. He said the major banks have lowered their base lending rate by an average of 275 bases points since August 2009, but loan volumes have not grown as a result. They have in fact declined by 3.6 per cent between June 2009 and June 2010 according to Bank of Jamaica data.
Stimulating economic growth
The real issue, according to Bowen, should be stimulating economic growth through a combination of macroeconomic stability, consumer and business confidence, access to and cost of capital. He further drew attention to the cost of doing business in Jamaica, including the economic cost of crime and theft, government bureaucracy and corruption.
Scotiabank's president and CEO Bruce Bowen provided participants in Mayberry's Monthly Investor Forum on Wednesday with a cursory glance at how interest rates are set in Jamaica. During the presentation, he hinted at the difference in how said rates are applied before and after the Jamaica Debt Exchange (JDX), a swap that saw the Government of Jamaica exchange its high interest earning instruments with those of lower yields and longer maturities.
One of the anticipated outcomes of the JDX was a significant reduction in interest rates as the rate on GOJ instruments were reduced. The JDX saw the interest payments move from as much as 23 per cent to a low of 12 per cent following its conclusion in February this year. The benchmark rates set by the Central Bank act as a floor for lending and investment rates.
"It represents the risk free rate and minimum return within a country," said Bowen.
Government's lack of fiscal discipline
In his presentation, Bowen suggested that the government's lack of fiscal discipline, which drove up rates and crowded out investors, was the main cause of high interest rates before the Jamaica Debt Exchange (JDX). However, after having suggested that there is stronger fiscal discipline as a result of the Stand-by arrangement with the International Monetary Fund (IMF), the often complained about still high rates were justified by the other factors contributing to their increase.
Among these factors is a four part formula that the banks use. That formula is a combination of the risk free rate, plus a premium for credit risk, a premium for operating costs and a premium for adequate returns to shareholders. All combine to determine the appropriate interest rate.
Little information on borrowers
But the formula gets a bit tricky. Bowen noted that because there is insufficient and inadequate information on borrowers, Jamaica's banks are faced with a task of trying to determine with such little information the credit risk of the borrower. This, he said would necessitate a higher credit risk premium than in countries where information on borrowers is accurate. Added to this is the relatively higher cost of collateral liquidation. In other words, in Jamaica the assets of the delinquent borrower are harder to dispose of when seized by the banks, hence the higher premiums paid by the borrower.
Jamaica's risk premium is also higher because of what Bowen describes as the economic volatility of the country and the increases in delinquency during recessions. He noted that Jamaica has been in a sustained period of recession for the past 15 years.
Loan delinquencies on the rise
To justify his point, Bowen pointed to the increase in non-performing loans and provisions for loan losses for commercial banks over three years beginning June 2008. Non-performing loan totals increased from 2.16 per cent in June 2008 to 5.59 per cent at June 2010. Provisions for loan losses also increased from 2.60 per cent in June 2008 to 4.42 per cent in June 2010. However Bowen did not indicate how the total amount of loans dispersed over the period had changed and how this may have impacted the level of delinquency shown.
Incurring operating costs
Banks incur operating costs to write the credit and administer the loan throughout the life of the loan, noted Bowen. Operating expenses typically represent over 50 per cent of revenues generated by the banks and inflation and contractual obligations can drive up these expenses over time, he said. Within the interest rate is a premium for these costs.
The final part of the formula is the appropriate return that is due to the shareholders and investors in the banks, including depositors. Bowen said that banks in Jamaica have to provide an "adequate risk adjusted return" to their shareholders.
"Jamaica's credit rating of B- requires higher risk adjusted returns," he added.
The risk premium argument was supported by comparisons with the credit rating of developed countries such as the US and Canada and developing country Trinidad, which have ratings of AAA, AAA and A respectively and the return on equity in local banks- another cause for contention- was compared with the ROE for banks such as JP Morgan, Citibank, Wells Fargo, RBC and Bank of America.
However, while there were favourable comparisons with the overseas banks, Bowen did not provide statistics about the performance of Jamaican banks, nor did he give any details of the cost reduction measures being taken that would cause more efficient operations.
Where's the beef?
He did not give any details of what the four components of the interest calculation were before the JDX and what they are now. For instance, if the banks were lending at 22 per cent with Treasury at 16 to 17 per cent, then what should be the calculations with Treasury at 8 per cent? Bowen did not explicate further into this issue.
And for those who make the argument that an interest rate reduction will lead to increased borrowing, more investment in productive activities, more employment and economic growth, Bowen had this to say: "Reductions in lending rates in an environment where business confidence is low has little impact."
The Jamaican experience has been paradoxical, Bowen pointed out, because GDP has not grown in line with the high investment rates seen in Jamaica. He said the major banks have lowered their base lending rate by an average of 275 bases points since August 2009, but loan volumes have not grown as a result. They have in fact declined by 3.6 per cent between June 2009 and June 2010 according to Bank of Jamaica data.
Stimulating economic growth
The real issue, according to Bowen, should be stimulating economic growth through a combination of macroeconomic stability, consumer and business confidence, access to and cost of capital. He further drew attention to the cost of doing business in Jamaica, including the economic cost of crime and theft, government bureaucracy and corruption.
Comment