In Defence of Interest spreads

Financial analysts say even though interest rate spreads have narrowed over the years, the size of the spread suggests that the banking sector is “uncompetitive.”

But bankers want to dispel that notion, saying that the market is being presented with a “distorted” view.  A recent report of the Cabinet appointed committee to review the financial sector in TT indicated that, although spreads have narrowed, compared to the era preceding currency liberalisation, they are still comparatively higher than those in some countries of similar size like Singapore or Malta. Spreads may be due to factors such as high reserve requirements and large risk exposure, the report said. A Republic Bank official said interest rate spreads, if quoted prime currently at 11.5 percent and is the reference point used to determine the price of lending, it will lead to a “distorted view.” “For instance, Government, the country’s largest borrower, is now borrowing at rates just above six percent, significantly below quoted prime,” he said, adding, “Interest rate spreads are not as high as it first appear.” With regards to the size of spread being an indication of uncompetitiveness, the official said as with every other business, market competitiveness is driven by supply and demand. “TT is well serviced by a wide range of financial institutions serving all segments of our market. With the current high levels of liquidity, the market is very competitive and all bankable projects are receiving fair attention.”

She also said in some areas, TT bank payments systems lag behind those of developed capital markets and countries, noting local payment for this country’s systems are essentially a paper-based one. Michael Callender, general manager, Group Marketing and Communications, RBTT Bank, noted that interest spreads in TT have narrowed significantly over the past two years, because the local market has become more attracted to newer types of financing such as capital market financing. He believes that spreads are likely to contract even further as the local capital market expands and competition increases. “There is really no comparison with Singapore and Malta’s economies. Market structures and culture are entirely different.” Competition in the consumer credit market, he said, is much more acute with the proliferation of credit unions which offer various types of financing arrangements. The committee was headed by Leroy Mayers and included Monica Clement; Dr Claude Denbow; Vishnu Dhanpaul; Lyndon Guiseppi; Martin Guevara; Dr Ralph Henry; John Jardim; Joan John; Claude Musaib-Ali; Gerard Pemberton; Subhas Ramkhelawan and Dr Ronald Ramkissoon.

Interest rate spreads is just one of the major weaknesses of the banking system, the commitee said, and went on to list credit allocation, reserve requirement, consumer and investor protection and interbank arrangements as major weaknesses in the local banking system. According to Stephen Allum Poon, Financial Comptroller, First Citizens Bank (FCB), the size of the spread is dictated by a number of factors, including the economy, reserve requirements and inflation.

TT, he noted, still relies on cash reserve requirements to control liquidity and these reserves demand that banks place funds on non-interest generating deposits with the Central Bank.
Interest spreads, he said, are expected to decline as the Central Bank improves and develops domestic capital markets and economic stability. “Reserve requirements will decrease resulting in lower loan and deposit rates and the competitiveness of TT as a financial centre will improve to attract investors as pricing becomes comparable.” Central Bank statistics for the quarter ending December 2002 for total loans outstanding by type, indicate that as far back as 1995, consumer loans comprised 44.8 percent of total lending to business and consumers. This percentile peaked in 1999 at 52.4 percent reducing to 47.3 percent in 2002. The reason, Allum Poon said, is mainly logistical as the consumer market consists of a large number of small value loans, and lending to business is fewer in number but higher in value.” He added that consumer loan business has been flat suffering from lower demand, although interest rates have fallen considerably. This, he said is due to increased excess liquidity and increased competition as the consumer has access to other sources of borrowing from non-financial institutions at less stringent terms and conditions than commercial banks. Commercial bank, he said, have in the most part retained their business portfolios.

For any financial institution, success depends on identifying growth areas for product and services.  Responding to the committee’s concern of the problems of fraud, misuse of funds and unauthorised sharing of confidential information, Allum Poon said banks are subject to regulatory rigour by the Central Bank in accordance with the Financial Institutions Act. He stressed that there is deposit insurance which protects local depositor’s fund, noting that FCB was enhancing its risk management policies and tools to create models allowing strategies to mitigate capital risk. Simone Penco, senior manager, Sales and Marketing in Scotiabank said she is not sure how TT compares to Singapore and Malta, but based on consumer demand, she noted that spreads have been narrowing in the country. “The Central Bank Governor has recently been quoted as saying that a planned phased reduction in the reserve requirement is carded and this is likely to impact rates,” she said.

Penco said Scotiabank’s statistics indicate that they have no bias to the business sector and “are lending just about equally to the two segments. There is no mechanism to allocate more credit to a specific sector.”