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Banks fear, won’t cut rates on loans

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Interest rates in the Czech Republic are at their lowest levels ever. But those who thought they would now borrow cheaply to buy a new flat or a new car will be disappointed. Only the Czech National Bank’s (ČNB) basic rate is at a record low only.

Under normal circumstances, interest rates on loans and deposits in banks should be derived from the basic rate, but that has not been true for loans for some time now. Even Thursday’s decision to cut the ČNB rates to 1.25% is not going to change that.

Bankers confirm this. “Our interest rates are stable, and there is no reason to reduce them now. Clients are much more cautious. They are borrowing less, and we are not pushing them into taking loans,” Česká spořitelna head Gernot Mittendorfer told HN.

As a result, interest rates on mortgage loans are still above 5% – according to the ČNB, the average interest on a mortgage loan in June reached 5.22%. For comparison, the average rate at the end of 2007 stood at 4.88% even though the ČNB rate was then 3.5% – considerably higher than today.

Banks fear
Some would describe banks’ behaviour as greedy, since the profits of most Czech banks are sound, albeit lower than in previous periods. Bankers say caution will enable them avoid losses in the future.

Why then are banks keeping rates high? First, one must understand how the central bank controls inflation and the entire economy through interest rates.

The so-called repo rate, frequently mentioned in the media, is the central bank’s most important tool: an interest rate at which other banks deposit money in the ČNB. They do so for two weeks in exchange for securities.

When the repo rate is low, commercial banks’ yield on such deposits is also low, so commercial banks cut their own interest rates on deposits. Moreover, it forces banks to search for better alternatives to earn interest on money — more loans to households and businesses. In order to find as many such clients as possible, banks reduces rates on loans.

In times of crisis, however, fear is the main factor motivating banks to keep rates high. Economic forecasts are getting worse and worse, which raises the likelihood that fewer businesses and households will be able to repay bank loans. According to estimates by investment bank Patria Finance, the proportion of unpaid loans in the Czech Republic should increase from the current 5% to 10% by the end of the year.

Banks are therefore raising their reserves because they still expect hard times to come. Komerční banka has increased its reserves for unpaid loans threefold year-on-year to CZK 2.8 billion. Still many analysts claim that it might not be enough and that banks are delaying the problem to the following period.

All these factors make banks think twice about who they lend to. Those clients who do get loans will pay heavily. This risk premium keeps rates on loans at a high level. The situation will not change until the economy improves.

It is not true however that there has been no response to the central bank’s steps. Interest rates on loans for businesses are decreasing, even though the decline is very slow and less significant – from 5.2% in January to the current 4.6% – than the decrease in ČNB rates. On the other hand, the rates for households have been growing steadily. There are several reasons behind the trend. First, banks are already able to better analyse a company’s situation and to better select clients whom they can lend money. But expectations of the economic development are the main reason. GDP should start growing next year, and the situation in businesses should start improving, but unemployment will remain high for some time.

In other words households, not businesses, will experience the biggest problems. Households are the most risky clients for banks. Komerční banka head Laurent Goutard confirmed this by saying that the first signs of a recovery among businesses will be in the coming months and next year, but it will be a very difficult period for retail clients. Businesses might see a decline in interest rates, but households should not count on it.

The fate of the central bank
What exactly is the central bank’s role in the whole situation and why does it keep cutting rates even when it does not have much effect? Simply put: because it can afford to. Its main objective is not controlling interest rates in banks, but fighting inflation. With growth in prices currently near zero, the central bank need not fear inflation and can boost the economy by reducing interest rates.

While the rate cut did not set commercial loans in motion, borrowing costs might have been considerably higher without it. Lower interest rates create a weaker crown, which enables exporters to generate more money on foreign markets.

The Thursday cut in ČNB rates was probably the last one, ČNB governor Zdeněk Tůma suggested. The economy should stop falling, so there is no reason for further cuts.

Effects of the ČNB rate cut

– weaker crown
Lower interest rates will make investors lose interest in the Czech currency. Exporters benefit because they receive foreign currency for their goods. On the other hand, Czechs have to pay more for holidays abroad and for imported goods.

– lower interest rates in banks
Interest rates on savings accounts and time deposits in commercial banks should decrease. So should interest rates on loans, but that has not happened yet.

– higher inflation
Easier access to money may motivate people to spend more and encourage businesses to invest. As a result, the economy and prices grow.

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