Namibia: Squeezing banks could be disastrous

Good as it may sound in the current economic crisis, this could trigger a series of dire consequences, including banks being forced to close rural branches and retrench workers, cut back on low-income products and become much stricter with loan applications, an independent research report warns.

The N$81 million loss that the banking sector will suffer also means that Government will receive N$28 million less in taxes paid by the sector. It may also mean even higher banking fees for consumers and could also hurt investor confidence, IJG Securities says in its report, Namibian Banking Industry: Margins Under Pressure.

In the report, the BoNs demand for lower interest rates is highlighted as one of the major threats to the local banking industry. Others include the increased pressure from Government to lower banking fees and to Namibianise key components like IT systems.

The research, an initiative by the local financial service provider, was sparked by the ongoing war on the interest rate spread between the central bank and the four commercial banks.

BoN Governor Tom Alweendo feels that the rate spread the difference between the BoNs repo rate and the prime lending rate of banks cannot be justified when compared to similar economies.

Earlier this year, he gave commercial banks until year-end to reduce this gap to 375 basis points. In the meantime, the Governor agreed to extend his ultimatum, provided the banks narrow the spread to 450 basis points and offer prime and home loan rates of 11,5 per cent by the end of October.

Nedbank Namibia is already in the clear as far as Alweendos demand is concerned, but Bank Windhoek, FNB Namibia and Standard Bank Namibia still need to cut their current mortgage rates of 11,75 per cent by 250 basis points.

Banks are very sensitive to lower interest rate margins, as they rely heavily on the margin to make profit.

Therefore, when bank margins come under pressure, banks tend to implement stricter lending criteria to reduce bad debts, IJG Head of Sales and Research Heike Smith said.

This will slow down the pace at which banks extend loans to the private sector, especially households, she said. It is therefore likely that the people benefiting from lower interest rates will mostly be existing clients, who will have more money in their pockets overnight, Smith said.

People could use this windfall to repay existing debt, but Smith felt that more money is likely to result in bigger spending.

The savers will have cushioned household finances against further interest rate increases, while the financial struggle will continue for the spenders when interest rates increase again, she said.

Smiths calculations, based on March figures, show that a decrease of 250 basis points will pump N$81 million into the economy. Half of this will boost consumers spending power, while the rest will go to companies.

Private spending of the entire N$41 million will mean that most of the money will flow out of Namibia, as the country imports most of its goods and services. The maximum amount of value added tax (VAT) that can be collected this way and boost state coffers, is about N$6,1 million, Smith said.

If companies opt to use their windfall for investment spending, their profits should grow and so the tax they owe the Receiver. Increased investment spending should also slightly increase economic growth, exports and job opportunities. Should companies prefer to use the millions they save from lower interest rates to repay debts or up savings, their profits should also increase.

However, this will be at the expense of the tax Government receives from the banking sector, Smith said.

N$81 million flowing to customers equates to a loss in the banking sector of N$81 million, which in turn reduces taxes paid by N$28 million per annum, she said.

Should individuals and companies decide to save the N$81 million, interest rates for deposits will come under pressure, Smith warned further.

Lower local deposit rates will encourage investors to search for better returns elsewhere and in likelihood the funds will flow to South Africa.

The outflow of money, whether in search for better returns of to pay for imports, will dampen economic growth, she said. Furthermore, lower profitability will encourage banks to apply stricter lending criteria. Smith said this means new loans to companies will be limited, which will hamper growth, employment and, again, taxes.

Lower rates and subsequently lower profits can convince banks to close rural branches and discontinue their products for low-income earners, reducing access to banking, Smith said. This may also lead to retrenchments and even banks opting to scale their services in Namibia down and rather becoming branches of South African banks, she said. Investor confidence may also suffer as a result of lower interest rates.

Lower interest rates would be an indication to investors that risks are not adequately rewarded in Namibia, thus making other investment destinations more attractive. This is the most serious unintended consequence of imposing lower rates in Namibia, she said. This could not only discourage new investors from bringing much needed funds to the country, but could also encourage existing investors to seek better opportunities elsewhere, Smith added.

Investor confidence could be further shattered if Namibias credit rating deteriorates as a result of the threats facing the Namibian banking system.

International rating agencies look at financial sector stability when they rate, which could be compromised by imposing a lower rate spread on the banking sector, Smith said.

Although the BoN may have its arguments for a decrease in the spread, IJG Securities believes that the Namibian operating environment and country risk profile justify a higher spread than in South Africa, she said. The rate in South Africa currently stands at 350 basis points.

If, however, a reduction in spread is unavoidable, this could be done in an increasing interest rate environment when banks are less vulnerable to re-pricing of deposits and when consumers are under more pressure from a riding debt burden, Smith said.

The Namibian