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Much
myth currently attends the practice of banking in the country. A lot of
it is understandably negative. Much of it acknowledges, and derives
from the critical roles banks are supposed to play (but apparently do
not here) in allocating financial resources within an economy. This
folklore explains the focus for a long time on the relationship between
banks’ alleged greed, and high domestic interest rates. Banks,
according to this narrative are in breach of their responsibilities to
the domestic economy each time lending rates reach “too high”. Then,
the real and extractive sectors will no longer be able to access the
credit without which they cannot meet their customers’ current needs or
grow their businesses. Domestic output growth thus suffers, and we are
all the worse for it. Consequently, the last two governments at the
national level have spent inordinate time absorbed by the challenge of
driving interest rates down.

The
error in this regard lies in the failure to accept interest rates as a
price, subject as with all prices to the push and pull of demand and
supply. And because the possibility of a market without distortions
exists only in the fevered imagination of the purists, not even the
price of money is spared the premiums and discounts that arise from the
improper workings of the money market. Rather than try by fiat to keep
interest rates down, a more useful response would have seen government
address the structural ~ impediments to the supply of funds to the
money market, or the hurdles in the way of growth in the domestic
demand for credit.

Misunderstanding the market

A
different misunderstanding of the market for long-term funds lies at
the heart of the more popular recent myth about the banking industry:
its supposed reluctance to lend for long-term investment. The main
sub-narrative here is the one that describes the nation’s banks as
unduly excited by near-term results, and consequently willing to lend
to distributors of fast moving consumer goods and importers of
consumables. The particular response of the domestic banking industry
to the second round effects of the global financial crisis has
exacerbated this opinion. Yet, one of the central lessons from the
crisis is that banks are best served by focussing on low cost deposits,
and credit creation, while leaving the much riskier investment banking
operations to dedicated boutiques.

If
this reading of the crisis is correct, there is something perverse
about requiring banks reliant on short-term deposits to drive long-term
investments in the economy. A much more useful procedure would be the
creation of a market for long-term investible funds: thriving bond and
new issues markets. Prospects for the latter will await a proper
response by the responsible regulators to the price bubble that
inflated on the exchange during the last boom. However, as regards the
market for corporate bonds, the markets’ response to government’s
recent policy interventions (granting tax-exempt status to bond
holdings, and creating a secondary market for such bonds by allowing
banks to include them for computing their liquidity position) shows
clearly the need for changes in the macroeconomic policy environment,
including structural reforms that remove the volatility that the market
prices into financial assets.

Economic illiterates

This
volatility, the result largely of economic illiterates determining
official policy, has left investors in the domestic economy with a
short-term horizon. It also explains the pricing of loan deals. High
and unpredictable inflation rates, along with the likelihood of
significant policy reversals means that most banks in the country can
only offer adjustable rate loans. With bank loans, therefore, companies
face an interest rates risk, which they can only hedge against at some
added expense. Besides, corporate borrowers face other concerns when
accessing bank loans. Most banks have a large exposure limit, capping
the proportion of their shareholders’ funds that they can legitimately
lend to a single borrower. Large borrowers must thus look for
syndication to meet their lending needs. Add to these, the cost to
borrowing companies of the “loan covenants” that are attached to bank
credit, and the financing needs of corporate Nigeria is best met
through the issue of bonds, and not through bank lending.

Long-term
fixed rate instruments simplify the budgeting process, and permit a
focus on the long-term. Would-be borrowers would however require some
form of rating from a recognised agency, and a sound investor relations
framework. This is the next reform level.