OTHER - 28 JAN 2019

Why are interest rates in Nigeria so high?

Why are interest rates in Nigeria so high?
Between 2000 and 2017, inflation in Nigeria averaged over 12%.

This article was produced on behalf of FINT, one of Nigeria's leading peer-to-peer lending companies, as we explore marketplace lending in Nigeria. 
 

Walk into a commercial bank as a small business owner in Nigeria, and you are likely to be quoted something close to a 30% interest rate on a five-year loan.

You are not alone.

Even large corporations are faced with remarkably high interest rates in Nigeria, with some manufacturing companies having to pay interest rates above 30% on loans. One thing we know is that Nigeria’s high interest rates stifle business growth and economic development, so why do they remain high?

To see why it’s so expensive for you to get a loan from the bank, we need to understand what determines that interest rate. In Nigeria, two important interest rates influence everything else.

The first is the monetary policy rate (MPR), the central bank’s benchmark interest rate, which acts as a guide for the minimum price of credit, i.e. it serves as a floor for interest rates in the country. The Central Bank of Nigeria fixes this rate, and in some countries, is the interest rate the central bank gives commercial banks when they deposit their funds there[1].

Nigeria’s benchmark rate is 14%, compared to 2.25% in the United States, 6.75% in South Africa, and 17% in Ghana.

The second significant rate is the one-year government treasury bill rate. When the Nigerian government issues a one-year treasury bill, it is effectively taking out a one-year loan, and because lending to the Nigerian government in Nigeria is completely risk-free (as the government can print money to repay), this rate guides banks in pricing credit for everyone else.

Nigeria’s one-year T-bill rate closed 2018 above 17%. What this means is that a bank would never grant you a one-year loan below this interest rate because it could just give the money to the government instead, risk-free.

So, the interest rate quote I get from the bank is determined by the MPR and the one-year treasury bill rate. But what determines these rates? Inflation.

We save and invest our money so that we can get a healthy return. For example, I put ₦1 million in a fixed deposit for one year because I want that juicy 15% interest (₦150,000). I put my money in it because I believe it makes me ₦150,000 wealthier in one year. But what really matters to me is the real return on my investment, i.e. what I can buy with the money I have. If inflation in the country is 20%, I am actually worse off at the end of the year because my ₦1 million has lost 20% of its value and I have only gained 15% on it. My real return is negative.  

Anyone lending money cares about the real return on money, so they are always going to price the interest rate above the inflation rate. If the inflation rate is 20%, then the bank gives out a loan at 25% so that its real return is 5%. Compare this to another country with an inflation rate of 5% and an interest rate of 10%. The real return? 5% as well.

In short, interest rates are so high in Nigeria because inflation has historically been high. Between 2000 and 2017, inflation in Nigeria averaged over 12%. This means that ₦1 million in 2000 was worth only ₦130,000 in 2017. In contrast, inflation averaged 6% in South Africa and 15% in Ghana during the same period. Notice that Nigeria’s benchmark interest rate is 14%, above the 21st century inflation average of 12%, and this maintains a positive real return on investment in the country.

The implication of all this is that for you to get a lower interest rate from the bank, Nigeria’s inflation needs to come down. This doesn’t look like it will happen soon as inflation has averaged 15% since the 2016 recession. Moreover, the reasons for Nigeria’s high inflation are structural and linked to our low productivity, weak manufacturing base, and small-scale agriculture.

High inflation is a significant cause of high interest rates in Nigeria, but it isn’t the only reason[2]. In time, we will explore more reasons for why interest rates in the country are so high. For now, anytime you get an interest rate quote from a bank, blame inflation.  

 

[1] This is slightly different and more complex in Nigeria. You can read more about the MPR here.
[2] For example, the MPR and Treasury bill rates tell us why interest rates would be above 18% but not why they would be as high as 30%.

This article was produced on behalf of FINT, one of Nigeria's leading peer-to-peer lending companies, as we explore marketplace lending in Nigeria. 
 

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