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Cutting Interest Rates Open to Question

Cutting Interest Rates Open to Question Cutting Interest Rates Open to Question

Struggling with the shortage of money supply and unfair competition with unauthorized financial and credit institutions, banks may not be able to comply with reduced interest rates ordered by the central bank. Former governor of the Central Bank of Iran Mahmoud Bahmani made the remarks on Monday, commenting on reports that interest rates may have to be cut once again.

Economy Minister Ali Tayyebnia said earlier in the week that the Money and Credit Council (MCC) could lower interest rates at its next meeting on Tuesday. MCC once lowered interest rates in April causing uproar in diverse sectors of the economy and financial circles.

The minister has proposed a 2% cut in interest rates which upon approval would bring down deposit rates to 18% and put lending at 22%.

In an interview with ISNA, Bahmani said, “even though high interest rates restrain economic growth and inhibit productivity, passing rules to lower interest rates regardless of banks’ capability to bear the lower rates is neither reasonable nor practical.”

Liquidity shortage is among the main reasons that prevent banks from keeping up with the low interest rates. Currently most banks are grappling with capital shortage and their debts to CBI are over and above the overdraft limit. On the other hand, the CBI is experiencing difficulties as well due to the government’s one quadrillion rials ($33.3 billion at the official exchange rate) debt to the bank. Reimbursing the debts will obviously raise banks’ capital and help improve their lending power.

 Irrelevancy

“Banks can’t afford to grant credit unless they have enough funds and resources, no matter how high or low the interest rates are or may be set.”

Referring to the banks’ general meetings with branch managers and shareholders to announce share dividends, he said instead of giving the dividends to shareholders, the profits must be used to meet banks’ capital requirements and enable them to grant low-interest loans because the cost of money is not compatible with the lending rate, a low figure that could decline further.

Islamic Treasury Bills (a version of short-term sovereign debt) and Musharakah sukuk (an Islamic bond based on joint venture) will not offer profits higher than the banks’ interest rate, he added. “If it happens otherwise, liquid assets would exit the banks and be invested in buying securities, disrupt the balance between money supply and cost and expose the banking industry to more severe capital shortages.”

Exorbitant rates offered by unauthorized credit and financial organizations and informal money market (uncertified quasi-banks and lending institutions) are also posing big challenges to the need to cut rates. “Unlicensed credit institutions are free to offer rates as high as 27% while the rates banks are now paying has dropped to 20% and may decrease further.”

Bahmani said if interest rates are cut again, depositors are likely to withdraw their money from official and authorized banks. He warned that even though the current situation demands immediate measures, any haphazard decision on rates will only hurt the banks and provide more oxygen to the uncertified lending institutions that have spread across the country like wild mushrooms.

Financialtribune.com