Why are loan interest rates so high?

The Finance Minister Audley Shaw has raised the question as to why the banks have not lowered their lending rates. He has quite correctly observed that when interest rates on Government paper were going up the banks would adjust their lending rates almost immediately after the announcement. Now rates are falling but the banks are not responding and are keeping strangely silent.

When the debt exchange was carried out earlier this year, the financial institutions all claimed that they were making a sacrifice in the nation’s interest and how much the move would cost them. But if you remember my article earlier this year, I stated that bank profits would not go down in comparison to last year but rather would increase. I stated that this would be due to three things, banks would lay off staff, service fees would be increased and there would be a reluctance to reduce interest rates. If one examines the financial reports of financial institutions, one would notice that nearly all banks, credit unions, etc reported profits that are higher than the previous year.

Now, National Commercial Bank has finally announced a reduction in some loans by three percentage points and in others by one to one and a half percent effective

August 1 2010. First Global Commercial bank has also announced a reduction of

two percent effective September 1 2010.

The real problem however surrounding the high loan rates is centered on the philosophy of the banks. Despite the recession that exists in the market, the banks are determined to see profits increase each year. In one of my recent articles I mentioned that increasing profits each year was an unusual phenomenon that was restricted to high interest rates/high inflationary economies. When inflation is high even a company that is inefficient will tend to see its profits increase. The real business cycle is for profits to go up and down depending on the state of the economy the competition that you face. The banks refuse to face the reality that the economy has changed and continue to operate as if under the old conditions.

Their situation is compounded by the fact that their loan portfolios are seeing increases in delinquencies which is having an adverse effect on their bottom line. The irony of the situation is that it is the high loan rates and service fees that have significantly reduced the ability of customers to service their loans. In addition many loans have been given for housing developments that are priced at levels where there is little or no chance of ever selling the units. The loan provisions are likely to increase and we will wait to see how the bank responds to that situation.