When the IMF released its financial outlook for 2018, one of the salient issues raised was the worrisome issue of non-performance of loans in developing countries. As a country that is now consistently leading the frontline in negative statistics, Nigeria was one of the countries listed with a high rate of non-performing loans.
Financial institutions especially banks contribute to the stimulation of the economy by giving out loans to help businesses enlarge their capital base to increase productivity. As a matter of fact, the capability of financial institutions to grant loans is based fundamentally on their liquidity among other things. One can say there is actually a bitter-sweet relationship between the liquidity of financial institutions and the performance of their loans. While the main source of a financial institution’s liquidity is from the deposit of customers, the ability to continually give out loans may be tied to interest recouped from already existing loans.
In essence, the more people deposit money in the banks, the more funds available to the banks to give out as loans. The repayment of these loans with interest accrued guarantees the repayment of deposits of customers that was pooled together to give out loans and also makes more funds available to give out more loans. This cyclical movement of how financial institutions use deposit of customers and other funds available to them to give out loans and the repayment of these loans with interest accrued is one of the major ways in which wealth is redistributed and the economy is stimulated to grow. Where loans are non-performing or under-performing, the result is very harmful to the economy. The reasons for the non-performance or under-performance of loans range from lack of due diligence, insufficient collateral, rising interest rates among others.
One important issue when giving out loans that cannot be overemphasised is the issue of interest rate. Perhaps when negotiating a loan agreement, one of the key issues that needs to be properly ironed out is the interest rate. The concept of interest rate is very dynamic. If an individual or a business applying for a loan does not properly understand the dynamics, they are bound to run into trouble. As a matter of fact, a vast number of non-performing or under-performing loans usually end up in litigation between the financial institution and its customer (“parties”). In these series of litigation, it is always discovered that one of the main issue for determination or probably the sole issue for determination revolves around the interest rate charged on the principal sum.
When giving out loans, banks charge interest rates. It is usually at a percentage and it compounds based on the tenure of the loan. Although the CBN is empowered by law to regulate interest rates, interest rates are arrived at by two basic routes. One is where the parties agree on what the interest rate should be. This is largely based on the concept of freedom of contract between parties, after all, agreement to take a loan with the promise to pay back at a later date with a specified interest rate is essentially a contract between a financial institution and its customer. The other route by which parties can arrive at an agreed interest rate is by the CBN guidelines. The CBN guidelines on interest rates is a compilation of interest rates in different sectors of the economy. What is pertinent to note is that the CBN does not fix a particular rate. What the guidelines do is basically to guide the banks by fixing a threshold rate and a ceiling rate. The bank is at liberty to fix its interest rate within the given range, that is, it can fix an interest rate anywhere from the minimum rate to the maximum rate provided by the CBN guidelines. Please note that the CBN mandates banks to publish these interest rates periodically in the media so that intending customers may see the rates.
Where an interest rate has been fixed unilaterally by the parties, they are at liberty to review the rates. A typical loan agreement will include a clause that allows the bank review the interest rate at any time during the pendency of the duration of the loan. However, where the interest rate is fixed according to CBN guidelines, either of the parties cannot review the interest rate outside the threshold stipulated by the CBN guidelines.
In practice, the banks usually review the interest rates periodically. The position of the law is that the bank cannot unilaterally review the interest rate without notice to the customer. While interest rates are not static, the law generally frowns on the arbitral review of interest rates. Where a loan agreement does not contain an interest review provision, the bank cannot review the interest rate. Most loan agreements usually contain a clause that mandates the bank to send a written notice to the customer on either the upward or downward review of the interest rate. Once it is established that the customer has gotten notice of the review, the bank can implement the reviewed interest rate in situations where the customer does not take any action as to the notice of review of interest rates. However, where the customer disputes the review, other mechanisms come into play as stipulated by custom or by procedure stipulated in the loan agreement.
Therefore, in applying for a loan, an intending customer should take cognisance of the dynamics employed to regulate the interest rate so as not to become saddled with accrued interests on the principal that will cause a serious burden to the customer.
