In an extremely timely speech to the Rotary Club of Kingston, Scotiabank CEO Bruce Bowen squarely faced the contentious issue of interest rates. Observing that “Like politicians, Bankers as a group are easy to hate”, Bowen focused more specifically on bank lending rates and interest spreads.

Referring to the Jamaica Debt Exchange (JDX) as a “defining moment” in Jamaican economic history, Bowen observed that everybody, Government and Bank of Jamaica (BOJ) included, were surprised at how successful it had been in reducing interest rates over what was still a very short period of only six months.

Whilst the yields on longer term securities, at around 12.5%, had not changed much since the JDX, short term rates have fallen sharply since December. The 90 day treasury bill rate has fallen from 15.5% to 8.06%, whilst the BOJ 30 day Certificates of Deposit rate had fallen to 8% at the end of August from 12.5%, saving Jamaica over J$40 billion in interest costs in the current year.

Jamaica had passed its second IMF test with tax revenues at 1.4% above budget, interest expense at 7% below budget, for total expenditure at 3.3% below budget.

The bank business model

The critical issue, according to Bowen, is what drives spreads, or what a bank earns on loans and investments, and what it pays its depositors.

Bowen argued that if Government securities are as close to risk free as we can get, then it only makes sense to lend money if one can earn a premium to compensate for the risk, including losses incurred. He noted that overall loan losses, measured as non-performing loans as percentage of total loans, had risen from 2.1% in March 2008 to 5.1% in March 2010, according to BOJ data. For BNS itself, loan losses had risen to 3.1%, trending upwards due to a weak economy.

Banks had traditionally relied heavily on spread or net interest margin. Using Scotiagroup data, he stated that the yield on credit cards was 35% (loan losses are expected to be high for this product), personal loans was 21% (included fixed rate loans that were running off), 16% on commercial (this yield was lowered by large corporates borrowing at a spread over treasury bills), mortgages at 13.5%, with the incremental dollar left over being invested in long term bonds at 11.25%. However, only 74 cents out of every dollar was available for these investments, as the BOJ required the banks to deposit 12% (down from 14% in July) in non-interest bearing reserves, and an additional 14% in short term liquidity, now earning a BOJ rate of only 8%.

On the other side of the ledger, costs include interest on demand deposits at 1%, term deposits averaging 6.5%, and repo liabilities of 8.5%.

Admitting that the overall relative margin was still high, Bowen observed that this was because raising deposits and making loans required a branch network, a bank’s biggest single non -interest expense. Scotiagroup has approximately 2,500 employees, with total salary and benefit expenses at around $7 billion per annum. Approximately 75% work in the branch network or supporting deposit and lending services, so, without including premises, utilities, security etc, it costs around $5 billion just to man their distribution channel.

Fees reduce costs

Addressing the currently vexed issue of bank fees Bowen said: “I’ve never met anyone who says they love fees.” The Scotia Group boss argued that the fees paid to cover the costs of specific services helped reduce the interest spreads required to cover the overall cost of their delivery. For example, addressing the issue of charging to deposit cash, Bowen observed that ScotiaGroup “was the last bank to introduce a charge on cash”. More importantly, banks “don’t make any money on cash” but only make money when it gets into the system “electronically”.

What can banks do to stimulate the economy?

Bowen accepted that banks needed to improve their efficiency “delivering services with a lower head count” through investments in technology (digital signature cards and document imaging), standardisation (credit scoring on loan decision making), and reducing costs for customers for routine transactions (an electronic direct payroll deposit is less than 10% of the cost in a branch).

“But, the Banks alone can’t ensure Jamaica’s success” says Bowen.

He believes that the government needs to do its part by sticking to its budget (avoiding excessive deficits), reducing the cost of government through improved efficiency (like the banks), and reducing “unnecessary costs” such as crime and corruption.

He is also of the view that the private sector needs to look for new investment opportunities beyond government paper, invest for the long term (not the short term) and avoid facilitating crime and corruption.

According to the president and CEO of the country’s largest banking entity,labour also needs to do its part, looking for opportunities to align worker’s interests with those of business, and tie pay to performance and productivity to improve global competitiveness.

“Jamaica’s challenges (decades of poor fiscal discipline and growing crime and corruption) were not created overnight, and are therefore not going to be fixed overnight either,” Bowen declared.