FORCED CEILING WILL NOT DECREASE INTEREST RATES
The issue of interest rates has become a major topic of discussion for Mongolia in the last two years. High interest rates on loans have been cited as a major source of financial burden to individuals and a hindrance to the growth of businesses. Since it is an issue that encompasses and affects all of Mongolian society, it has inevitably been politicized.
Many previous administrations have tried and largely failed to decrease interest rates. The current Cabinet headed by Prime Minister U.Khurelsukh is proposing a ceiling for interest rates in an effort to force a decrease in interest rates.
Cabinet has submitted an amendment to the Banking Law to Parliament, effectively establishing a hard cap on the interest rates of loans provided by commercial banks. This move has been immediately criticized by the Mongolian Bankers Association (MBA), which stated that if the new amendment to the Banking Law being discussed in Parliament is approved, it will significantly damage the investment and business environment.
Mongolia’s financial system is dominated by the banking system, which accounts for almost 95 percent of the total financial market. It has been this way since the transition from a centrally planned economy into a market economy in 1990. The stock market makes up less than five percent of the financial market. As a result, loans from commercial banks are the main source of financing for both individuals and businesses.
A cap on the interest rate is not new, as many central banks around the world employ it as a regulatory measure that prevents banks or other financial institutions from charging more than a certain level of interest. However, it has been widely recognized that governments that employ this tactic often do it for political purposes, rather than economic.
This does not mean that an interest rate ceiling is not a useful economic tool. In fact, many central banks around the world employ this tactic surgically to supplement certain sectors where credit is being insufficiently provided. Therefore, it is possible for Cabinet to implement a more flexible interest rate ceiling that only affects certain sectors.
The current Cabinet’s take on the issue is to set a rigid interest rate limit on all loans. This is a move to appease the public and create the perception that concrete action is being taken. However, Cabinet is trying to cure the symptoms of issues in Mongolia’s financial system and completely ignoring the root problem.
The interest rate can be likened to a price of a particular product on the market, it is not determined by only one business but the whole market itself. Just as the government does not try to put a limit on the price of a bottle of water, it would be unwise to try and set a limit on the interest rate.
It has been almost 30 years since the government of Mongolia stopped determining and enforcing the price of products on the market. At a time when the economy was centrally planned, the government was the sole producer and supplier in the market. Therefore, the government was free to determine the price without the consequences that a similar move would entail in a market economy. Trying to tackle issues with the same mentality that was prevalent in Mongolia’s government during socialism will simply not work in today’s economy.
“Regulatory measures to establish a ceiling for interest rates has never had their intended results in around 80 of the countries that have implemented similar measures. On the contrary, capping the interest rate will increase loan risks and decrease inclusion and equal access,” stated MBA.
MBA believes that such a measure could be counterproductive in that it increases interest rates instead of decreasing them as intended.
The drafters of the amendment have said that more than 74 central banks around the world employ this measure. Cabinet Secretariat and sponsor of the amendment, G.Zandanshatar says that such a measure is necessary as commercial banks are essentially competing through interest rates and this has become a burden on businesses. The Cabinet Secretariat explained that the measure wouldn’t have significant detrimental effects on commercial banks.
In order to lower interest rates more sustainably, the government needs to take more action systemically and support reform in the financial sector as a whole. The recently proposed interest rate ceiling is a politically motivated short-term solution that will have farreaching and incalculable economic consequences.