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M Jamsaz, Ph D, Consultant Economist
M Jamsaz, Ph D, Consultant Economist

Monetary Policies and Rate of Interest

Monetary

Policies and

Rate of

Interest

The Act on Bank Interest Rates recently passed by the Iranian Parliament has raised a huge wave of opposition and resistance among many government circles particularly in the state controlled banking system and in the Management and Planning Organization.

The opposition maintains that lowering the interest rates will result in a considerable reduction of monetary resources of the banks as people will tend to withdraw their deposits from the banking system. The Act, they maintain, will consequently create a deep gap between the unofficial monetary market and the banking system.

At present 93% of the liquidity in the country is absorbed by the banking system and yet bank resources cannot cover all the application for bank facilities and credits, and this shows that the current rates of interest charged on credits do not discourage people from borrowing.

During the period beginning with the Third Development Plan till now, long-term deposits have been growing rapidly and the ratio of credits granted to deposits received by the banks has increased from 52% in 1997 to 88.45% in 2003. This fact and the numerous demands for bank credits at present interest rates, all indicate the validity and acceptability of the current rates.
Furthermore it would be unjust to lower the interest rates paid to the savings to a level below the inflation which would mean that effectively no interest is being paid. To this must be added the 4% that the banks charge as their minimum expenses (1% for management expenses, 1% for risks as some loans may never be paid back, and 2% attorneys’ fees). No one, however, refutes the validity of lowering interest rates in the right circumstances.

The advocates of the Act maintain that about half of the total amount held by banks as deposit accounts are interest-free accounts to which no interest is paid. Therefore, the average rate of interest paid is, in practice, much less than what is declared by the Central Bank.

This article does not intend to offer a critique on the pros and cons on the Act, but since, according to current economic theories, interest rates do affect the productivity of capital, the article insists on policies that allow interest rates on credits to fall leading to higher productivity and consequently a rise in investments and, therefore, to production and job opportunities to rise.

Of course, one must accept the fact that the problem with investment and production in Iran does not arise only from interest rates, but is the outcome of many factors such as heavy taxes, strict labor laws and regulations, and complicated and costly bureaucracy. As long as these factors exist, investment and lower interest rates will not have the necessary effectiveness unless they are imposed within the framework of a series of suitable reform policies in which case measures such as this Act will show their desirable effects.

But, in the present circumstances it appears that the system of bank deposits and that of facilities and credits and distributing these facilities is such that an 8.5% reduction in credit interest rates and 4% reduction in deposit interest rates over a period of three years will not achieve the goals because the banking system, instead of being at the service of the private sector, is primarily at the service of the government. It would be interesting to note that only a 1.5% of the resources available to the banking system is provided by the government but 50% of bank resources are used by it.

Furthermore, costs are imposed on the banking system which it transfers to the public sector such as costs of receiving payments for 200 million statements (water, electricity, telephone…) and other expenses of providing services for the government free of charge as well as granting 28% of all bank facilities to government organizations and related entities at an interest rate of 3.5%: another heavy burden that is ultimately borne by the private sector.

But according to the Fourth Development Plan the amount of credits that banks are obliged to put at the disposal of various state organizations is supposed to decrease by 20% each year. If enforced, this will free a considerable part of bank resources, which banks can then put at the disposal of the private sector.

This will certainly play a very significant role in the credit interest rates and, in the right circumstances, will lead to increases in investment, and consequently to total revenues and as a result total deposits.

MoneyIn the present circumstances, a reduction in bank expenses, expansion of e-services of all kinds of bank services, and most important of all the independence of the Central Bank (from state control) in setting monetary policies, will result in much higher productivity of the banking system.

Presently the rate of cost-to-revenue in the banking system is 89% (2003). If this rate declines, productivity will rise allowing lower credit interest rates. Studies must be carried out and proper policies adopted to make reductions in the interest rates, as suggested by the Act, feasible.

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