Interest Rates for Dummies

Following the monetary policy meeting of 21st of September 2010 the Central Bank had agreed to increase the MPR to 6.25% sighting the troubling increase of inflation rate, which is not about 13.7% for August 2010. The MPR(monetary policy rate) is the rate which the CBN lends money to Banks. Surprised? The banks go to the CBN from time to time either to deposit part of the money you keep with them (by law) and go to the CBN to lend money when the money in their vault is not enough to meet customer withdrawals. They do this by applying a margin of 2% below the MPR for deposits and 3% above the MPR when they want to lend to banks. So, whilst the CBN accepts deposits from the banks at 6.05% it lends to them at 6.55%, well so I think.

Ordinarily, news like this do not deserve a second look from the everyday Internet savvy buff like you and I who is probably more interested in some funny facebook status messages or what new video D’Banj has on cue. You can’t blame yourself or me for that matter. Interest rates, inflation rates and all them financial “jargons” really don’t soothe the nerves of the hustle and bustle of an everyday Eko chap. It also doesn’t explain why the roads to your house is so bad whenever it rains, or why on your way home you probably need to worry about getting fuel to run your generator or think of how to pay for that damn BIS lest you miss out on the virtual anti-social social networks of this world.

But then, interest rates do and should concern you and I in more ways than you can ever imagine. A lot of businesses in Nigeria whether you like it or not depend hugely on Bank loans for their survival. Most of them borrow at rates as high as 25% per annum excluding all sorts of hidden charges. Even your typical consumer loans and car loans which I’m sure you, yes you, or well someone you know, probably used it to buy a car or pay for a house rent or even furnish your house are given at rates equally as high as 25% per annum too.

The impact of this is not felt unless I really break it down to you in simplistic terms. Supposing you earn a salary of N200, 000 per month (tax exclusive) and probably save about N50,000 with your bank every month leaving you with N150,000.. You suddenly think you need a car to get by and have identified a car costing N1.5m as ideal for your self. But since you work for some of these organizations that don’t give staff loans your left with no choice than to approach a bank. The bank, if you’re “lucky” will offer you the loan at 80% of the value at an “all in” interest rate of about 25%pa. Working that out (depending on the amortization format you use) it comes to about N40k every month. By the time you finish paying for that car it would have cost you an extra N700k over four years in interest. This is aside from the cost of maintaining the car, paying for insurance and fuelling the car over the period as well.

As savings deposit rates typically earn about 5% per annum at their peak, the N50k you saved (which by the way is more than the principal you are paying the bank) with that same Bank over the same 4 year period would probably be worth N2.6m with N315k as interest. Juxtaposing that with the N40k you pay to the bank you realize whilst the bank lent N2.4m from you over the 4 year period it paid you N315k as interest while you paid them N700k on the N1.2m they lent you. Ah ha, now you get the real picture yeah. So with the increase in the MPR don’t be surprised to see your consumer loan repayments go a notch higher in the next few days as Banks are usually don’t hesitate to increase rates at the slightest opportunity. This and many more ways are how the banks reap us off. They (the Management that is) charge these exorbitant rates , use the money they get to ride flashy cars, build mansions, get medical treatment abroad whilst rendering us bankrupt. Being a chain reaction, once we are bankrupt we can’t pay back their loans which makes them insolvent and ultimately a failed bank finally culminating in the Government bailing them out with funds they would have used in providing basic necessities of life which we so much lack as a country.

Back to the central bank, they’ve had a knack for making so much about bringing the lending rates to single digit territories for as long as, well I wrote my project. If I recall, my project was exploring the “possibility of a drastic reduction in the inflation rate of the economy” and I bet I didnt know halft the meaning of what I was writing then. However, I did know that Central Banks deeply loathe inflation or its direct opposite deflation for several reasons. Inflation is generally referred to as the rise in the cost of goods and services in an economy. As such economist usually blame a rise in the cost of goods and services to an increase in money supply in the economy. Meaning there is plenty money in the economy or literally money in too many people’s hand leading to plenty money chasing fewer goods consequently leading to a rise in cost of goods and services. So to mitigate this, the CBN will usually use its powers to manipulate interest rates thus leading to the recent increase its MPR to 6.25% pa.

What I usually don’t understand in all of this is, amidst the poverty and lack of credit to the productive sector of the economy, who is in possession of the increase in money supply that they are talking about? Certainly not you and I considering that, we probably have had a pay cut in the last one year, lost a job or seen the value of the naira erode on a daily basis due to our perennially dependent income economy. That is where I see the “dummyneess” in all this interest rate cut and inflation gist perpetuated by the CBN. Rather than own up and blame the rise in the cost of goods and services to our ever import dependent economy which erodes the value of the Naira on a regular the government continues to play the dummy game and use western style economics in a country where statistics and data are simply not available to buttress their assertions. Inflation, if it actually is the 13.7% they claim should be blamed on what is likely the actual cause, corruption, rather than a fictitious increase in money supply to the economy like we do not form part of this economy. The only thing that can possibly cause an increase in the cost of goods and services in Nigeria is when corrupt politicians; public and private workers divert money meant for viable projects into their pockets. They like to use western style policies to adress 3rd world problems even when the symptoms and disease are so so different. Unlike the West where increase in money supply can be statistically proven, we do not have a logical proof to explain the movement in inflation. I do know however, that when this corrupt politicians get money it is at no financial cost giving them the leeway to spend at will and at any cost. It is these people that will buy a land worth N1m for N10m and deposit N100m with a bank at 12% for as long as they wish rather than use the money to create businesses that create jobs. That is arguably the major reason why our inflation rate never drops. Little wonder we achieved single digit inflation during the Abacha years as he alone was stealing the money and stashing them abroad rather than spending them in the country.

So, whenever you see them talk all that jargons about inflation rate, interest rates etc tell them they are for dummies and not for you and me. This doesn’t stop us from reading them as you have a responsibility to ask your banks for a reduction in the interest rates of your loans whenever the dummies announce a reduction in their so called MPR. You should also make efforts to look through your bank statements on a monthly basis and fish out those fraudulent charges which may at first seem insignificant. Interest rates are for dummies so be smart and don’t be fooled.