1 month ago
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Traditional media and social media are replete with complaints on banking fees and the quality of services provided by commercial banks in Jamaica. While these complaints are not without merit, I have no issue with the commercial banks as regards their response to changes in the Bank of Jamaica’s policy rate.
The interest rate is a price. It is the price of holding money in our wallets or the price of taking a loan. There are different interest rates, just as how there are different prices for the many goods and services available for sale in an economy.
Interest rates can be divided into two broad categories: loan rates and deposit rates. It is important to note these two categories whenever the BOJ policy rate is being discussed.
To better appreciate the information presented here, readers must divorce themselves from their individual experiences and appreciate the aggregate picture and an understanding of weighted average interest rates.
Put simply, if Peter borrows $99 million at an interest rate of 5.0 per cent and Robert borrows $1 million at 10 per cent, then the weighted average interest rate will be approximately 5.0 per cent; Peter’s interest rate dominates simply because he borrowed a significantly larger amount than Robert.
The BOJ policy rate is the interest rate paid on overnight deposits held at the central bank by deposit-taking institutions, or DTIs, such as commercial banks and building societies. In 2021, the BOJ started to increase its policy rate; the first time it would have done so since it started cutting rates back in 2017, the year when the central bank officially adopted an inflation targeting regime.
By 2022, commercial banks were lambasted for not increasing interest rates on deposits commensurate with the higher interest rates the commercial banks were receiving from the BOJ. In keeping with its mandate to ensure low, stable and predictable inflation, the BOJ increased its policy rate from 0.5 per cent to 7 per cent, between September 2021 and November 2022. During this period the world economy was still suffering from the shock of the COVID-19 pandemic, and this was compounded by the Russia-Ukraine war. Inflation was on the mind of every central banker.
The BOJ followed the basic prescription which says that to prevent inflation spiralling out of control, a central bank should increase its policy rate along with other policy measures aimed at reducing the amount of money in the economy. Commercial banks are a primary plank in this project and are expected, not required, to follow the BOJ’s interest rate policy direction.
INTEREST RATES
Indeed, since commercial banks were receiving higher interest rates on their deposits with the BOJ, then they should also pay higher interest rates to their depositors. I do not recall any agitation for an increase in the interest rates on loans, but such increases are part of the usual prescription which supports increases in all interest rates, thereby slowing down economic activity. People save instead of spending, and firms postpone expansionary projects. However, increases in the interest rate on loans can increase the production costs of firms, thereby fuelling price increases.
Fast-forward to 2024, with inflation comfortably within the target range of 4 to 6 per cent, the BOJ, like other central banks around the world, started to lower its policy rate. The commercial banks were lambasted again for not moving quickly and decisively to change interest rates commensurately. The chorus from the private sector was, of course, loud as firms pleaded with the commercial banks to lower interest rates on loans.
On the issue of interest rates on deposits, there is a high correlation between the BOJ policy rate and the weighted average interest rate on time deposits. In fact, the correlation got stronger after the start of inflation targeting in 2017.
On the other hand, the correlation between the BOJ policy rate and the interest rate on savings was significantly less. These revelations indicate that persons who truly wanted to save had the option of simply moving their funds into a time deposit account.
Interest rates on loans tell a different story. The correlation between the BOJ policy rate and mortgage rates was quite low, so much so that mortgage rates remained relatively flat when compared to changes in the BOJ policy rate. The same can be said for commercial credit rates.
It is critical to note that there has been an overall decline in mortgage rates dating back to 2017. While the BOJ’s policy rate was raised between September 2021 and November 2022, the weighted average mortgage rate declined marginally from 7.10 per cent to 6.95 per cent for the same period, and by December 2024 it rose to 7.48 per cent. A very similar pattern is seen for the weighted average commercial credit interest rate, which was at 9.36 per cent in September 2021, declined to at 9.28 per cent by November 2022, and rose to 11.29 per cent in December 2024.
The evidence shows that commercial banks have acted prudently in their interest rate changes. Interest rate on deposits, especially time deposits, increased commensurately with BOJ rate increases, while there was no proportionate increase in the interest rate on loans.
Much has been said about the need for greater competition within the commercial banking sector. What is often missed is that the nature of the sector leads to concentration of business amongst a few banks, especially in a small island developing state where the ‘duppy’ of a financial crisis remains in the collective memory of many.
Over time, the sector will become less concentrated as smaller banks are able to increase market share by increasing their footprint by such things as ATM coverage and banking halls. Technological advances, too, could lead to more competition.
It should be noted that in the world of loans there is much more competition. Customers may shop around for the lowest car interest rate or mortgage rate, and perhaps this partly explains the differences in changes to interest rates on deposits and loans seen in the data.
Dr Samuel Braithwaite is a lecturer in the Department of Economics, University of the West Indies, Mona.samuel.braithwaite@uwimona.edu
English (US) ·