Economy, Business And Markets

Interest Rates: A Double-Edged Sword

Interest Rates: A Double-Edged SwordInterest Rates: A Double-Edged Sword

Interest rates have been a recurring theme in Iran’s business and market climate during the outgoing fiscal year (ends March 19). After many ups and downs and heated debates, the Money and Credit Council finally approved interest rate cuts for the second time on Feb. 20, with one-year deposit rates at 18% and lending rates at 20%.

During this interest rates drama, opposing views were heard from across the economic spectrum. Some said the rate cuts would be futile and fail to lift the recession-plagued economy. Others openly censured the efficacy of implementing rate cuts by fiat. However at the end of the day, Iranian banks agreed in a meeting to lower rates, a decision which was later endorsed by the MCC.

Tejarat-e-Farda weekly, a sister publication of Financial Tribune, published an interview with the CBI deputy chief for banking supervision affairs, Hamid Tehranfar and asked him about the consequences and dimensions of the rate cuts.

Tehranfar admits that the latest cut is yet another example of “lowering rates by decree.” However, he noted that doing so is not necessarily negative and has its own pros and cons. He defended the rate cut as the right decision given the country’s current economic reality.

“Lowering rates paves the way for lifting the economy out of recession and puts an end to the lenders’ destructive competition in offering high deposit rates. On the other hand, lower lending rates increase the demand for credit and by extension give rise to rent-seeking and corruption,” Tehranfar argues.

Elaborating on the effects of the recent rate cut at the macroeconomic level, he said government officials believe that lowering rates can help lift the economy out of recession to a certain degree by “motivating businesses and entrepreneurs to re-energize their activities, especially in the production sector.”

 Sensitive to Rates

The senior official said almost all domestic lenders have incurred losses in their intermediary activities related to money and this is all “a by-product of high deposit rates.” He recalled that depositors are very sensitive about the rates banks offer and will transfer all their money to another bank even for a slightly higher return.

“As a result of this approach by depositors, banks are under pressure and go to great lengths to offer higher deposit rates to satisfy their customers and prevent a possible outflow of money from their bank,” he said.

The second point complicating the issue of deposit rates for banks is related to the belief of branch managers that success means absorbing more deposits, according to Tehranfar. “Branch managers say lower rates cause depositors to pull their money out of the bank. They think less deposit accounts means they are simply not successful or good.”

According to Tehranfar these factors create a vicious circle regarding deposit rates which necessitated outside intervention. “The CBI and the MCC were intervening to put an end to this vicious cycle and destructive competition over deposit rates.”

Tehranfar says that although the cuts have been imposed from above, banks are seemingly satisfied with the measures because lenders are no longer able to pay the high deposit rates and are more than willing to see an end to the poisonous competition.

Asked about how the banks can afford to pay high returns on deposits, Tehranfar said lenders “sell their property to provide the resources for paying the returns.”

 Role of Big Players

He also pointed to another woe besetting the domestic economy, the phenomenon of big institutions parking their money in banks.  According to him, these organizations have emerged in the form of “institutional depositors.”

“A financial institution like an insurance company deposits a huge sum of money in a bank. This is dangerous because it gives the organization the power to determine interest rates and pressure the banks to keep deposit rates high. The banks offer high rates in order to keep the pile of money in their bank preventing competitors from absorbing the huge deposits,” he expounds. The official stated that interest rates were lowered to deter banks from going to extremes to satisfy their customers appetite for high rates. He admits that the people are disappointed with the CBI’s decision but adds that because of the safety of keeping money in the banks “people will not take the trouble taking their money out and invest it in rival markets like gold, forex or the capital market.”

 Consequences of Low Rates

The lowering of interest rates changes the composition of deposits in banks according to Tehranfar. “Long-term deposits are transferred to short-term and overnight accounts,” he expounds. Decline in banks’ short-term deposits undermine the banks’ ability to lend and this is one of the downsides of lowering rates by decree, he admits.

“In addition, the high volume of demand for loans has caused lending rates to remain high and as there is high demand and very limited resources, cutting lending rates may create the grounds for corruption and emergence of middlemen and brokers.”

Asked about the possible consequences of lowering rates on the manufacturing sectors, Tehranfar said there is some misconception in Iran that the banking industry has a duty to grant loans to everyone, especially to producers. “In the global business arena, production units are not normally dependent on banks and finance their projects through several other ways.” He did not elaborate.