The basic interest rate at a commercial bank is considered to be the one at which placements to the best clients are approved. Differences in interest rates between different bank clients should only reflect differences in credibility. However, other factors also influence the differences. This refers to realized balances and other transactions that the client has with the bank. The bank takes into account the cyclicality and propulsiveness of the business that the borrower deals with. By the conjuncture in the economy, the sector and the borrower's participation in the market available to him. The state of the company itself, the level of inventory, the state of fixed assets, etc., is reviewed. Based on the above, it is clear that the cost of loan approval, risk assessment, is the factor that determines the difference in the rate from the base rate. Administration costs are passed on to clients, either in the form of interest rates or special fees. The formation of interest rates, both active and passive, is left to the banks operating on the territory of Montenegro.
For long-term placements, the range of interest rates until June 2003 ranged from 0,17% to 2,51% on a monthly basis. In the case of securities, the active interest rate ranged from 0,65% - 1,27% on a monthly basis. In the case of short-term placements by banks in Montenegro, the interest rate until May 2003 was in the range of 0,12% - 3,15% on a monthly basis, but even in September the upper limit was quite high, at around 2,85% on a monthly basis . During 2003, we had a situation where the interest rate was 3,15% on a monthly basis, which gives an interest rate of 42% on an annual basis. The question arises, in conditions where the means of payment is a convertible currency, what are the jobs that suffer such a high interest rate. The first impression is that these are speculative and high-risk jobs, or incredible margins.
Today, we have a more favorable situation compared to the period 20 years ago, despite the significant growth of EURIBOR of 4,05% in the period of the last 18 months. The average effective interest on newly approved loans, that is, the interest that includes all costs, had a big growth in one year from 5,04% in September 2022 to 7,05% in November 2023.
In terms of interest rates on deposits, we can conclude that we have a similar trend in Montenegro as in Europe. One explanation is that Europeans are not prone to risk (up to 100.000 euros of savings are insured, while in Montenegro it is up to 50.000 euros) or they are simply not aware of alternatives for safely depositing their hard-earned money, or both factors are involved. In the same period, the average interest rate on deposits in Montenegro decreased from 0,26 to 0,24%, however, you should know that in the Montenegrin banking system you can get up to 4% per annum on a term deposit, which is above the average of EU banks.
The price of money is determined by available sources of funds and business risks. Risks are understood as the creditworthiness of the client itself, as well as the economic environment, financial infrastructure and efficiency of state institutions, especially in the collection of overdue loans. I would like to remind you that at the beginning of 2024, we have almost 20.000 companies and entrepreneurs with blocked accounts, worth around 1,2 billion euros. The average time of court proceedings, from the accusation to the collection judgment, is about 3 years.
Interest rate policy
Taking into account that we are using foreign currency, the issue of interest rate formation should be approached with special attention. In developed countries, the main instrument of monetary policy is the short-term interest rate. Central banks have several types of techniques in order to influence the movement of interest rates, but they all boil down to one way or another in influencing the price of money in the banking system. In general, for this purpose, the banking system is granted a higher or lower volume of funds available for business. The conditions of operation in our country impose the mandatory reserve of banks, prescribed by the Central Bank of Montenegro, as the main instrument of monetary policy. The reserve requirement was set at the level of 23% on deposits up to 1 month in 2003, while today in 2024, depending on whether they are short-term or long-term deposits, it is 4,5% and 5,5% of the base amount, while in the EU is 1%, where until January 2012 it was 2%.
Interest rate policy should be based on the monetary authorities' assessment of the possible level of inflation for the next few years. When building these estimates, all available indicators are taken into account, such as: demand, level of production, employment, growth of monetary mass and credit requirements, value of assets as well as the value of the domestic currency. Every rise in interest rates has its own causes. The monetary authority would have to monitor, analyze and react to any disturbance in the movement of interest rates. For any change in interest rates, it would be normal for the monetary authority to go public with an explanation of the factors that caused the current situation.
The state of illiquidity of the economy requires that the Central Bank either reduce the base for allocating banks' mandatory reserves or the percentage that is calculated. The lack of funds is obvious and conditions the increase in interest rates, which have a chain effect on the creation of inflationary pressure. It is necessary to take measures that would ensure a better supply of the market with money.
The Central Bank of Montenegro acts as the fiscal agent of the Government of Montenegro. In order to replace the budget deficit, auctions of Central Bank treasury bills are held in the name and for the account of the Ministry of Finance. The interest rate achieved at these auctions, in developed countries, is published with the aim that all other base interest rates are formed on the basis of the average interest achieved at the auction. This interest rate is, in principle, lower than the prevailing interest rates on the money market, given that placement with the Central Bank is considered the safest placement, i.e. placement without risk. During 2002, the interest rate achieved at auctions ranged on average from 7 - 8% on an annual basis. Worrying was the trend in 2003, which indicated that the interest rate of these securities went up to 12,5% on an annual basis. In addition to the large cost that is created for the Budget on the basis of interest payments on this basis, the mentioned data also indicates a lack of funds in the economy, which is expected taking into account the level of the trade deficit, the level of internal debts and the need to service overdue domestic and foreign obligations.
At the third auction of government bills held on December 20, 2023, which was conducted by the Central Bank of Montenegro for the needs of the Ministry of Finance, 20 million euros were collected. The notes mature in three months, and the interest rate was 3,75% pa
I would like to remind you that we have a real negative interest rate in bank placements, where the official inflation for 2023 was 17%, and the average interest rate at banks is around 5,75% on an annual basis. In a one-year period, the Euribor increased from 0 to over 4% in August 2023, which influenced the increase in interest rates in Montenegro as well. The transfer of this impact of interest rate growth to the Montenegrin market was to a lesser extent than was the case with the European interbank market. Today, the average interest rate in the placements of Montenegrin banks is around 6,45%, while the EURIBOR is 4,05%. You should also know that the average interest rate in placements with good companies is at the level of around 3,85% per year, which is below the six-month EURIBOR price. We have to admit that the results, taking into account all the circumstances, are of very high quality.
It should be recalled that banks in Montenegro have enabled all clients who have loans with a variable interest rate to switch to a fixed interest rate and thus have predictability of obligations. The available data on the structure of housing loans indicates that there has been a significant reduction in loans with a variable interest rate since the beginning of the EURIBOR increase, from 35,08 to 9,9%.
During the first two quarters of 2024, I do not expect a drop in interest rates, but already in the second part of the year I expect a drop in EURIBOR, which will also affect the average interest rate in the system. Forecast After more than a year and a half of the previous period, the cycle of monetary policy tightening is over, because inflationary pressures are gradually easing, and the danger of deflation and recession is present in 11 EU countries, which indicates the need to ease the restrictiveness of monetary policy. However, in addition to monetary, there are also external influences such as wars with global consequences, tension in relations between the largest economies such as the USA and China, an election year in the European Parliament, the USA, Russia and South Africa as an important country on the continent where international interests, and unfortunately also natural disasters or pandemics can have a negative impact and correct the assessment.
The author is the Secretary General of the Association of Banks of Montenegro
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