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New interest rate pricing model goes into coma

*As CBN changes gear on publication of interest rate

By Babajide Komolafe
The new interest rate pricing model announced by the Central Bank of Nigeria (CBN) is yet to take off four months after it was announced. The apex bank has also reversed itself on the requirement  that  banks should publish risk criteria for determining their interest rates as earlier announced.

CBN boss

“We said that it should start by June, it is true, it has not started, monetary policy take note. We accept, it has not been done, we will do it.”

“We did not say that banks should publish, we said that banks should give to the CBN, their interest rate pricing model,” CBN Governor, Mallam Lamido Sanusi said, when confronted about the delay in the commencement of the new model at  the annual workshop for Finance Correspondents and business Editors in Benin, Edo State.

But the Monetary Policy Committee (MPC) in the communiqué issued after its  special meeting on April 15th  said, “ DMBs would be required to regularly publish and submit their risk_based interest rate pricing model to the CBN”.

Similarly, the apex bank in a circular issued in May said “They (banks) are required to render monthly returns on, and regularly publish (on a website, newspapers, and other periodic reports) showing the relationship between the MPR and their prime and maximum lending rates.” The circular titled, “The Need for Banks to Develop and Implement a Risk_Based Pricing Model, was signed by  the Director, Banking Supervision, CBN, Mr. Samuel Oni.

The model termed Risk based interest rate pricing model was announced by the announced by the apex bank at the end of a special monetary policy committee meeting in April.

Under the new model, banks are required set interest rate based on the risk attached to the loan and they are also to disclose to the public the risk criteria used in determining their interest rate as well as the spread between their interest rate and the Monetary Policy Rate (MPR). The aim of the new model was to promote transparency with respect to interest rate charged by banks and hence drive down interest rates.

The MPC stated, “It believed that promoting transparency in the pricing and setting of rates by DMBs could help to drive down lending rates. For the avoidance of doubt, the MPC will not fix lending and deposit rates by fiat. However, every bank will be required to disclose the maximum spread it charges above the MPR to its prime customers and the risk premium it charges between prime and maximum lending rates.

The pricing model would also disclose the basis for the spread and principal components covered. The articulation of the pricing model in this mode and its disclosure to the general public will serve two purposes.

First, by providing visibility on relative efficiency of financial institutions, banks will be encouraged to seek profitability by driving down costs and charging competitive rates rather than charging excessive rates of interest. Second, by explicitly stating prime and maximum lending rates as a fixed spread over MPR, the policy rate becomes an effective tool for driving lending rates up or down as policy stance dictates.”

Thus, the publication of  risk criteria for determining interest rate by banks is a  major aspect of the new model, and critical to achieving its objective of transparency and competitive interest rates. But with the CBN changing gear on this aspect the new model has been rendered ineffective even before take_off.

Investigation however revealed that even the new position of the apex bank might have been influenced by opposition of the banks to the requirement. In fact  it was gathered that most of the banks have not submitted their risk based pricing  model as mandated by the apex bank in the May circular .

According to the circular, “Banks are advised to be guided by the following parameters, in addition to the risk premium, in determining their prime lending rates. Each of the cost element or component as described below should be separately computed and disclosed as part of the information to be made public.

Direct Cost of funds:_ Direct interest cost of funds should be interest expense related to the monthly average volume of deposits and other funds reported to the CBN on a monthly basis.

Indirect cost/overhead:_ Ail indirect cost/overhead incurred by the bank should be included in the determination of the prime lending rate. The overheads to be separately disclosed include staff cost, bonuses, executive compensation, loan loss provision, administrative cost, etc. Overhead cost for  the month should be expressed as a percentage of the average volume of funds and annualized.

Statutory cost:_ Statutory cost to be included in the computation of the prime lending rate should include the following: a) NDIC Premium. The amount payable as deposit insurance premium in each month should be expressed as percentage of the average volume of deposits for the month and annualized; b) Cash Reserve Requirement (CRR).

Banks are expected to adjust the prime lending rate by taking into account the opportunity cost of deposits that were sterilized as CRR; Opportunity Cost:_  Of holding liquid assets In excess of the minimum requirement Without prejudice to the maintenance of strong liquidity position, banks are encouraged to balance the desire for liquidity and profitability.

The opportunity cost here will take into account the bank’s average yield on earning assets other than liquid assets vis_a_vis the average yield on liquid assets.

Cost of holding non_earning assets:_ This is the cost of holding assets that do not generate any income. Banks are advised to reduce their holding of non earning assets to the minimum.

Target return on equity:_ The rate of return expected by the shareholders of banks should also be factored in the computation of the prime lending rate of banks. The expectation however, should be guided by economic fundamentals and long term sustainability of the institutions.

Flat Fees:_  To ensure standardization of charges across the industry and align Nigerian banking practice to international standards, the Bankers Committee issued the Guide to Bank Charges in 2004. Banks were required to ensure compliance with the provisions of the Guide, however, in recent times, the CBN has observed the proliferation of flat lending fees charged by banks in violation of the Guide, which has led to many complaints by members of the public .

To arrest this situation banks are henceforth required to note that aggregate flat lending of the facility amount. The  details of all fees shall be communicated and agreed with the borrower and disclosed by the bank.   The returns as highlighted above shall, with effect from April 2010, be rendered on the 5m day following the reporting month.”


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