Historical collapse of National Bank discount rate: What will happen to loans and deposits?

Author : Anna Peshkova

Source : 112 Ukraine

Earlier that he IMF approved Ukraine a new $ 5 billion loan and transferred the first tranche, the National Bank set the lowest discount rate in the history of our country - up to 6%. A year ago, it was three times higher.
22:04, 16 June 2020

Open source

This was needed in order to support the weakened economy due to the Covid-19 pandemic. But this indicator will affect the welfare of not only the whole country but also each Ukrainian individual. The discount rate directly affects the lives of citizens: loans, deposits, mortgages, and, indirectly, even the dollar exchange rate.

How the discount rate will affect prices

If the bank’s customers withdrew more money from their accounts than its management expected, the financial institution has to apply to the National Bank for financial resources. The regulator can lend money at a certain percentage. The lower the discount rate, the more profitable the bank refinancing from the National Bank is. It becomes less interested in the money of Ukrainians, which means that it reduces interest on deposits. But loan rates are also falling. Therefore, the rate is so important.

How does the National Bank determine at what level to keep it?

The NBU usually sets the discount rate based on inflation, that is, on the pace of the rise in prices for goods and services. If the regulator expects prices to rise, it increases the rate. If inflation is low, it lowers the rate and thus pushes commodity prices up.

It works like this. Since deposits are usually less profitable when lowering the discount rate, companies and individuals are less interested in storing money in banks. They spend capital on goods and services. The fact that demand for goods is growing accelerates the economy.

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Previously, the rate was extremely high in order to slow down price increases. According to the State Statistics Service, inflation in annual terms slowed to 1.7%.

“Low inflation of 1.7% shows that Ukrainians will use the hryvnia more, focus less on the dollar price of goods, and, in particular, real estate. The importance of the currency will decrease, the hryvnia will work actively, and this is positive for the country,” says the economic expert Taras Kozak.

But it is important to maintain balance. Too serious the cheapening of Ukrainian goods can lead to an economic crisis. In the case of deflation, that is, a reduction in prices, entrepreneurs will receive less for the goods sold than they expected in production. In industry, deflation in December was already 7.4%. And then the coronavirus pandemic provoked a sharp decline in economic activity. Prices are falling, which is negative for Ukraine: as you know, it is a commodity country.

A simple example: in 2013, deflation of 0.5% was observed. During deflation, wages are usually reduced, workers are fired.

Analysts say the ratio between inflation and the discount rate should be about 1 to 1.5. That is, there were all prerequisites for lowering the discount rate: it could even be lowered to 3%. Economic expert Oleg Pendzin recalls that the Polish rate is at the level of 4-5% per annum. In the EU, it is 0.25%. Mitigation of monetary conditions is generally a global trend.

But further relief is unlikely to happen. The National Bank says that in the near future this is the last such "action", and now the rate will be stable until at least 2022.

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If we talk about the direct impact of lowering the discount rate for ordinary Ukrainian, then usually this means that going to the store will be more expensive for him and deposits will become less profitable. The chances of a job reduction will decrease, and it will be easier for him to take a loan. But the coronavirus pandemic slightly changed this alignment.

The loans

Ukrainian entrepreneurs are credited on average at 18% per annum, while in neighboring Poland loans are issued at 2%. Because of this, a domestic business cannot develop normally. After lowering the discount rate, loans can become cheaper by about 1.8%. This will only affect new customers. For the old, the terms of the contract will not be changed, unless the floating rate has been specified in the contract.

Cheap loans will push the economy. If, for example, the sector is credited more, then this will also lead to the development of its related segments.

But there are a few problems.

Firstly, there will be no instant changes. Typically, Ukrainian banks lower credit and deposit rates after lowering the NBU discount rate for a month and a half. Now, most likely, we will face deferred influence. Long-term loans will become cheaper very slowly and selectively. Economists agree that in 2020 there will be no major changes - they should be expected in 2021. And for entrepreneurs, a slight easing in loans after the "post-quarantine depression" means nothing.

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Secondly, interest rates on loans can hardly change in practice. In addition to accounting, bank risks are also included in interest on loans. The investment climate in the country is still not improving, the system has a large number of problem loans, the rights of creditors in the courts are poorly protected. The financial situation of borrowers after quarantine is also difficult. And this means that there are no serious prerequisites for cheaper loans.

And the connection between the discount rate and loans is weakening more and more every year. Economist Olexandr Okhrimenko emphasizes that the discount rate in America is the basic factor for loans. But for Ukrainians, in his opinion, it has ceased to be of practical importance, because financial institutions are less and less borrowing from the regulator. The process is corrupt: the decision about which institution to give a loan is decided behind the scenes in the parks with a cup of coffee, the expert emphasizes.

Taras Kozak is not so negative about the impact of accounting, but also believes that this year you should not count on profitable loans.

"There will be no cheap loans. The discount rate has an indirect relation to their value. A reduction in accounting only shows the direction of interest rates in the markets, opens up the possibility for their reduction, but does not guarantee this," the analyst explains.

The government could count on an increase in lending unless it would compensate banks for part of the interest rates on loans. But, given the deficit of our state budget, this is a long way off.

A chance to fulfill a presidential promise

Mortgage rates in the country are high - about 20% per annum. And with additional payments and commissions, contributions to health and life insurance, a mortgage can be even more expensive. Ukraine is generally in the top countries where it is the most difficult to get a real estate loan. In Denmark, by comparison, banks even issue interest-free mortgages.

Theoretically, now the mortgage could fall in price to the promised by the president 10%. Such an indicator is enough for banks to earn their margin. However, Taras Kozak calls the announcement of Zelensky wishful thinking. He emphasizes that this year it is impossible to reduce the mortgage to 10%, as banks have no resources for this. He does not hope for refinancing from the NBU. To issue loans at least at 9.9%, deposits must be at the level of 7%, which is still a long way off.

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And again, banks lay down their risks in the price of mortgages. And the risks are great: last year, mortgage lending decreased by 7%. In a post-quarantine situation, at least high requirements for the borrower will remain. These are age restrictions, the term of work in the last place for at least a year, as well as a salary of at least 740 USD per family member per month. It is unlikely that many citizens will pass such a test, but on other conditions, it is pointless for financial institutions to work. It is easier for them to invest in reliable bonds, securities.

The president, of course, can try, as in the case with gas stations, to force banks to do something, but these are private structures, and they have the right to earn money as they want. Therefore, the next "tea parties with a guarantor", most likely, will not end in anything.

In addition, a boom in mortgages requires not only a simplification of lending conditions but also an even more significant reduction in interest rates. For Ukrainians, even 10% of mortgages are a heavy burden: the average apartment, which was taken on credit, will cost one and a half times more expensive. This is still a significant overpayment. A real boom in mortgages can occur when monthly payments are at least approximately equal to the cost of the rent.

But if the mortgage eventually comes to life a little, you can predict a surge in interest in real estate. This means that housing can rise in price, especially liquid one, that is, a new building.

What will happen to bank deposits

In May 2020, the average interest rates of banks on new deposits in hryvnia for the population amounted to 11.4% per annum. Typically, a reduction of 1% leads to a drop in mortgage rates by 1.1-1.3%. That is, they could be reduced to at least 9%. The rate level can have the maximum impact on 3 months' deposits.

Does this mean that now the demand for deposits will fall? Experts have different views on this.

On the one hand, deposits are really becoming unattractive. But, on the other hand, the population has almost no alternatives for deposits. Investing in private funds is a very risky undertaking. It makes sense to invest in government bonds only to those who have substantial amounts on hand. Deposits are familiar to everyone. Even if fewer people take them, given the recent increase in demand, we can assume that this will not be critical for banks.

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But investors do not have to rush to conclusions.

"Deposit rates will not fall immediately by 2%, but slowly. Next year, Ukrainians will get used to the fact that the yield on them will not exceed 10%, about 9-8%," Taras Kozak says.

In terms of time, a lot will depend on the reaction of the largest state financial institutions. As soon as they begin to lower rates, a collapse can be expected throughout the system. So there’s still time to put a stash in the bank at higher interest rates.

Will the dollar grow?

It was possible to reduce the rate to the current level about a year ago. But it was artificially taken away from realities for the sake of high yield on bonds of the domestic state loan. Such was the strategy for repaying the state debt for a time, while the IMF did not give us the tranche.

The delay was also explained by the fact that it was necessary to systematically evaluate the consequences of reducing the accounting for our economy. Experts also saw the reasons in the corruption interests of officials: allegedly representatives of the Ministry of Finance and the NBU profited from the high profitability of government bonds.

Now, when the first tranche of the new program is finally provided, the tactics have changed. And with it, the dollar exchange rate may also change.

In the wake of previous statements by the head of the National Bank, Yakiv Smoliy about lowering the discount rate, the dollar usually rose in price. Since the yield on government bonds decreases, non-residents show less interest in them. So, they buy less Ukrainian currency to purchase bonds for dollars. According to the law of supply and demand, this pulls the price of the currency up.

But Ukraine still has a high yield on bonds. In many countries with strong economies, government bonds generally have negative profitability. Therefore, it is likely that non-residents will still tear tidbits from the Ukrainian state debt, and the effect on the dollar upward will be minimal. If the Ukrainian bonds lose the interest of non-residents, and the country needs additional financing, the NBU can always return the discount rate to the previous level.

But you need to consider other factors affecting the dollar. The very fact of providing Ukraine with the IMF tranche, according to Taras Kozak, will push the currency to around UAH 26 per USD 1. He believes that keeping money in dollars is not worth it right now. In the current situation, in his opinion, it is worth paying attention to bonds, even though their profitability will be reduced.

In general, Ukrainians will hardly feel the positive effect of lowering the discount rate. We may not see the boom in loans and mortgages not only this year but also next year. But deposits will slowly become cheaper. Therefore, it is necessary to change the monetary policy as a whole, to do everything possible to protect the rights of creditors and improve the conditions for doing business in the country.

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