Banks are likely not to lower their lending rates despite the fact that central bank has loosened its policy rate in an effort to spur lending and boost economic growth.

Last week the central bank lowered further its key repo rate—at which it lends to commercial banks—by one percentage point to 6 percent from 7 percent. 

Steve Caley, the Chairman of the Bankers Association, says that even though the repo rate is reduced, banks will not automatically shift from short and medium term placements in money market to loans, contrary to the central bank’s objective. 

"This consists of various factors like bank’s appetite, risk assessment, profitability or even the bank’s general policy as regards diversification of its income generating
activities,” Caley told Business Times in an interview last week, casting doubt on the effectiveness of the central bank’s decision.

The central bank said the decision was based on the current low inflation trend that is projected to continue fluctuating between 1.4 percent in December and 4 percent in March 2011.

While the central bank’s deliberate low interest policy is essentially to stimulate lending to the private sector and reduce incentives for banks to invest in the central bank’s instruments, commercial banks are still reluctant to issue new credit mainly due to high risk perception of the market.
Caley said that money market placements are almost risk free which is not the case with loans to customers.
Commercial banks have shied away from offering specifically long term credit, opting to buy government bonds.

For instance, a two-year, 2.5 billion Rwandan franc ($4.2 million) Treasury note in August attracted Rwf7.6 billion in bids.

While new authorized loans to the private sector significantly picked up, the outstanding credit to private sector has been slower than expected increasing by about 10 percent by end this year, well below the 20 percent growth initially projected.  

In addition, lending rates on the market remain untouched on average soaring between 16 percent and 17 percent.
Lending rates decreased to an average of 16.8 percent in September this year from 16.9 percent in March, figures from the Central Bank indicate.

"Banks will not immediately rush to giving out loans because of the 1 percent cut in repo rate,” Caley said.
According to the Chairman who also doubles as the Managing Director of Fina Bank, a secondary effect of the central bank’s decision could be that banks’ treasuries will now tend to place longer term in treasury-bills and bonds as opposed to repo and calls of 1 to 28 days where rates are generally over 6 percent.

"Though this might be envisaged in the future so as to maintain the same or target higher levels of income. But again loans have to pass through well established processes where each individual bank has its own strategy of doing business; some banks will respond faster, others may be a little bit late,” he said.

In balancing the bank’s investments opportunities Caley argued, there will always be a reasonable portion of the bank’s assets held in money market placements.

"Profitability wise, the longer the tenor, the higher the income, which might justify the shifting from 1-28 days instruments to longer tenors and yields in the form of treasury-bills and bonds,” Caley observed.

However, he also pointed out that banks will consider various alternatives as some may opt for increased lending, which will more than compensate for the 1 percent reduction in income.

The challenge for the banks Caley observed is that demand for credit continues substantially to be for long term projects whereas banks have short term liquidity.

"There is also a great deal of demand for projects that are not able, in the first instance, to indicate viability. We also expect the Credit Bureau to have a beneficial effect in that it will be easier to weed out the traditionally defaulting names who apply for credit.” 

Last year contrary to 23 percent growth planned at the beginning of the year, outstanding credit to private sector fell by 1.8 percent as a result of the liquidity crunch experienced between the last quarter 2008 and the second quarter 2009.

Ends