I write to grease the call by President Nana Akufo-Addo as the above subject suggests in the 13th of November 2019 issue of the Daily Graphic. Interest rates form the basis of economic activities in every economy, and if handled well propels real economic fortunes; but the reverse will accelerate economic doom. Over the years, Ghana has witnessed high cost of borrowing making prices of goods and services unstable among other nations in the West Africa sub-region, especially Francophone countries. This call has become necessary in the wake of high costs of goods and services leading to disputes between domestic borrowers – traders – and their foreign counterpart retailers who have access to cheaper borrowing facilities.
Currently, Ghana has over 90 percent of its population in the informal sector struggling to battle with this high of cost of borrowing that can be traced to improper regulation of financial products-pricing that includes risk premium, determination of the interest rates, and calculation of the interest. It is surprising to note that the majority of these unrecorded economic activity players have little or no knowledge of financial procedures to help them bargain their bids prudently, but are left at the mercy of these overly-ambitious profit-oriented financial institutions.
This is one of the variables used in arriving at the total costs of a financial product; this risk is subjective to the credit rating of the person or the business prospecting to borrow the facility. Depending on the track-record of borrowers, financial institutions may settle on high or low rates at their discretions…which is a moral issue. As said previously, government and its financial market regulators have nothing or little to do with determination of risk premiums, since we operate free market economy. Unfortunately, this is where most financial institutions like savings and loan companies, microfinance institutions, rural and community banks among others overprice their products. This Ghanaian phenomenon of making abnormal returns by price instead of volume, at the expense of an unsuspecting public, is part of the reason for high financing cost in the country.
Interest Rate Determination
The Bank of Ghana has introduced the Annual Percentage Rate (APR) for determining costs of borrowing in the Borrowing and Lending Act 2008, (Act 773) and its Additional Provisions (Disclosure and Product Transparency Rules for Credit Products and Services, February 2017), which are not adhered to by many financial institutions.
Simply put, total cost of borrowing is equal to owners’ funds or principal interest plus all other and estimated costs etc. to the loan acquisition. My recent sampling of some Pre-Agreement Truth in full disclosure statements (Payment Schedules) from some formal financial institutions showed that interest charged over principal is far higher than the interest rate quoted in the offer letter.
Secondly, insurance and processing fees were exclusive of the total costs as against their definition in Act 773 as other costs (OC). These fees, although they are one-off payments, form part of the total interest charged and must be treated as such. One-off payment does not make them additional costs to the borrowers as defined by the Act, Annex 1, Calculation of Annual Percentage Rate, Bank of Ghana Directive.
In financial literature, there are two (2) major ways of calculating interest rate depending on loan type which are both fitted into the APR formula. They are Reducing Balance Methods (monthly) and annual (flat method); and the Bullet Loan Interest Method. The monthly reducing balance method is when the principal instalments (Pa) paid previously is deducted every month before current interest is calculated. Hence, interest charged for every month varies, but total interest is calculated net one-off fees and averaged. This average is added to principal instalments (Pa) to form the repayment amount.
The annual reducing balance (flat rate) method bears the same method of calculating monthly reducing balance method; but as though there are monthly principal instalment (Pa) payments, interest charged is calculated on yearly basis and divided by 12 (Simple Interest Method). But in the subsequent year, all principal instalment (Pa) payments in the previous year(s) must be deducted before flat interest is again calculated for each month. This means that interest charged can only vary from year to year. This method is widely used by most financial institutions in order to protect fund owners’ interests against variability.
Fixed interest is charged on bullet or balloon loans, which means that the whole principal is paid on the date of maturity; and there will be no principal instalment (Pa) payments during the period of the loan till maturity. For this reason, it is prudent to pay fixed interest during the period. Normally, this type of loan is appropriate for seasonal cash flow businesses like cocoa or other cash crops, farmers, schools and others. To my surprise, some financial institutions, especially microfinance and savings and loan companies, charge fixed interest to principal deductible loans – enjoying hidden interest of over 100% at the blindside of unsuspecting clients.
The aggregate effects of the above analyses are both visible and invisible high interest rates we are experiencing, which are translated to form part of the costs for goods and services we complain about daily. Unfortunately, our vulnerable markets men and women who started their businesses with their personal savings after accessing microloans from these institutions face possible business collapse or become stagnant. The persistent agitation of domestic traders over cheap imports is also evidence of the effects from high interest rates, among other things. This also affects our stock of foreign exchange, as foreign traders are rather encouraged to import substitutes and repatriate their earnings.
The Act has outlived its usefulness and needs to be updated to reflect current dynamics in the financial market. The review should clearly spell out the issues of loan-pricing options in the offer letters to borrowers. For example: type of loan and interest calculation; clear procedures of loan contracts; when and how borrowers become contract-binding among others. The regulator(s) must carry out this task by constantly sampling offer letters and payment schedules to validate their compliance. In the wake of collapsing financial institutions as a result of bad practices, reward and punishment systems should be properly defined to be set as guides for them.
The writer is a Post-Graduate Research Student Development Studies, IDTM, Cape Coast.
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