Most Jamaicans when they get their pay or monthly income they place it in a savings account from which they draw cash for their daily or monthly expenses. This deposit is essentially a loan to the bank, and when banks report these deposits on their financial statements they generally report it on the liability side of their balance sheet, In other words it an item that it owes to other parties. Now in return for making these deposits customers of banks typically expect interest to be paid to them, and most banks do that for savings accounts paying in the region of two to four per cent depending on the type of savings account and the amount that is deposited there.

To obtain the interest that they pay to depositors banks lend the money they receive in deposits to borrowers who need funds for productive purposes or for consumption. These loans the banks list on their asset side of their balance sheet. Typically banks charge rates that range from about 16 per cent in terms of auto loans to about 45 per cent for unsecured loans such as those made with credit cards.

One reason why there is such a large difference between the interest rates paid and the interest rates charged is that there is often a challenge finding credit worthy borrowers, particularly in an economy such a ours which was grown very little over the past few years. So banks have to balance the relatively few ‘good loans’ with the relatively large number of deposits that they are receiving. Now as can be seen from this arrangement the banks need to pay close attention to the number of bad loans that it has as it needs to be able to meet the obligations of the depositors (any perception of inability to do so may result in a run on the bank which may ultimately cause the bank to collapse).

Investors can earn more than savers

As noted in previous articles, a fixed income investment is largely a loan from one person or entity to another. Now I would like to take the opportunity to look at two of the more common types of fixed income investments and two of the safest as well, certificates of deposit or savings accounts and repurchase agreements and the risks involved.

The repurchase agreement simply involves an investor making a short term (usually 30 – 35 days)fixed income investment with a securities dealer for which they get paid interest (2-8.5 per cent depending on the amount invested and the period). The securities dealer takes these funds and buys fixed income securities (which are approved by the FSC) to provide slightly higher rates of interest (9-11per cent) so that it can pay the investors. The risk in this case is the movement of interest rates, if interest rates move upwards investors typically immediately want the higher interest rate that is paid, and want to hold onto higher rates if interest rates move lower, whilst the broker may be stuck with lower interest bearing paper or having to buy lower interest bearing paper.

So the main types of risk in both cases are credit risk in the case of saving accounts and interest rate risk in the case of repurchase agreements.

Bob Russell is the assistant vice president, structured finance at Mayberry Investments Limited. He can be contacted at bob.russell@mayberryinv.com.