The parliament is about to make changes to the law on banks. It is true that we need to align our banking controls and risk management with international principles and norms (i.e. Basel standards), and increase the independence of the central bank. However, some populists are attempting to set maximum loan rates at commercial banks. This step would be the last push that will throw our economy off the cliff.
Real reason why loan interest rates are high
The average interest rate offered by our commercial banks today is 22 per cent for loans annually, and 14 per cent for savings. This shows that money supply is too low on the market, while demand for loans is soaring. In other words, although people have freedom to run a private business, which is the basis of the economy, they are increasingly finding financial sources too inaccessible and expensive. Jobs are hard to find because private businesses are unable to expand. In the meantime, nearly 10 per cent of our 1-million strong workforce have gone abroad to work in countries such as Korea and the Czech Republic.
Despite having vast mineral resources and big headcount of livestock, our economic circulation still desperately needs capital. Given it has only been 20 years since Mongolia started its path to democracy and a free market economy, our population today consists of relatively fewer middle income earners, a small number of wealthy people who inherited or have huge savings, and some who are only beginning to accumulate wealth. Mongolians are living on loans because our people do not have enough cash and we are unable to attract foreign capital.
When people have more than enough capital to meet their own needs, they transfer some of it to those who need it, so that generation of more value can be funded. This is how an economy develops, and there are two major platforms that facilitate such type of transfers: money market and capital market. You can say that Mongolia’s money market today is open while the other platform (capital market) is essentially disabled.
Regardless of its duties to offer equal opportunities to economic players, create a favorable business environment, and set restrictions only on safety and environmental issues, our government is now doing business itself. This is how Mongolia’s economy is stuck where it is today.
Our government must be operating in a transparent way, but its activities have become too secretive, allowing the authorities to steal from public funds and land. It enabled corruption to flourish and block the progression of our political and economic institutions. This environment has allowed a few wealthy people to centralize power and authority and fight against each other, which is the reason why our governments last only a year and a half now.
Due to the instability of government and unpredictability of policies, domestic and foreign businesses are unable to expand. State-owned companies are increasingly becoming political party-owned, and every time these companies run a deficit, which they do always, it is made up from the public budget. The funds that are supposed to be going to our society’s primary needs such as schools and hospital are feeding the corrupt. Only the corrupt are getting wealthier and have seized authority and power using political parties.
The key reason why we have a shortage of cash in Mongolia is our oversized government, deficit-running state-owned companies, and the corrupt who are stealing from public funds. But, instead of fixing these issues, our MPs seem to be more focused on setting maximum rates for loans at commercial banks.
Putting a ceiling on loan interest rates
Many countries have used different means to limit loan interest rates, but they were not successful in the end. A World Bank study shows that a total of 76 countries (including France from 1935, Japan from 1954, Namibia from 1968, Uruguay from 2007, and Kyrgyzstan from 2013) pursued such policies.
For example, as a consequence of this policy, Japan and Germany saw a drastic decrease in goods and services targeted at low-income families. Eighteen countries in Latin America saw the cost of exchange rise, because their banks charged clients various fees in order to keep up with their costs (Capera, Murcia, and Estrada, 2011). The United States oversaw improved opportunity for business owners to acquire loans after restrictions on interest rates were abolished. It also triggered migration from states with restrictions to those without restrictions, and an increase of illegal loans in jurisdictions where interest rates were restricted (Bodenhorn 2007). In Japan, such restrictions reduced the number of loan applications and increased illegal loans (Ellison and Forster, 2006).
When such dire consequences are observed in the law-abiding Japan, this type of legislation would immediately lead Mongolia to her next economic crisis.
How to reduce loan interest rates?
Loan interest rates should be reduced not by force, but by the law of demand and supply. In order to decrease the rates in long term, we need to make our banks more transparent and increase free competition. This is the only way to have them think of new products to be offered to people, and reduce the percentage of revenue from loans as a part of total revenue. It would also allow for improvements in micro loans and services.
Mongolia needs to make its economy healthy and competitive by reducing government involvement in the economy, stopping corruption, privatizing state-owned companies, and freeing up prices.
On the other hand, we need to improve financial regulations intended for client protection and to enhance people’s financial education.
This would allow the capital market to develop, hence enabling the second platform to facilitate the flow of cash, which would eventually result in lower interest rates.
2017.11.22
Trans. by B.Amar