Trust me, I am not writing this to defend Nigerian banks. I am writing to explain how the banking system works. In a post where I shared the profit margins of publicly traded companies in Nigeria, many of our members were not happy that banks were well represented, even though they hardly offer affordable loans to small businesses. Those sentiments are justified but those are not the full story. Read on…
The Central Bank of Nigeria (CBN) recently raised its benchmark lending rate to 18%. With that, you can have the total cost model from a typical bank on lending thus:
- Lending rate from CBN (Central Bank of Nigeria): 18%
- Cost of deposit insurance (NDIC, etc): 0.5%
- Expenses: 2%
- Margin: 3%
So, expect your bank’s minimum loan rate to be at least 23.5%. Of course, there are other sources of capital which can make it possible for banks to lend at sub-23.5%. Typically, funds from DFIs (development financial institutions like African Development Bank, and African Export–Import Bank) can make that possible but those coming from CBN will be at least 23.5%.
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The implication is clear: the high interest rate is not a bank’s fiat decision.
Then you will ask: why can’t CBN lend to banks at 2%? The issue is inflation. If you make the cost of capital very low, bad things could happen, as the economy is flooded with easy money, resulting in the cost of goods and services rising.
So, managing inflation and strengthening the currency could be defined as the core roles of any central bank. Yes, central banks work mainly to stabilize or strengthen their currencies (to reduce inflation) and create employment by managing interest rates. While they can make lending rates low, they also need to consider that easy money can ravage their currencies. Simply, those high lending rates are not 100% on the banks.
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Is this the full story or part of the story? Let’s look at it practically and responsibly.
The common definition for inflation is too much money chasing few goods, is that really the case in Nigeria? From practical standpoint, forex arbitrariness fuels inflation here more than any factor advanced in Economics textbooks. So, which of the two objectives of the central banks have been fulfilled with high interest rate: reduction in unemployment or keeping inflation low? The verdict will return neither. We can decide to interrogate further by probing the why.
As for the lending margins by banks after the CBN benchmark, who determines 2% as expenses and is it also codified? 2% of N10 million is N400k, can we call this a fair deal for disbursing N10 million? And there’s still a small case of 3% profit margin…
Import heavy economy cannot use the tools developed economies use to fight inflation or unemployment, since what fuels inflation in both economies are different, that is why they are ineffective in our case. We do not have oversupply problem, yet the CBN keeps deploying measures as though low interest rates fueled excess supply, it is not true.
Again, our banks are designed to work with only those who are already succeeding.