Central Bank lifts rate caps on lending products as rates soar

• Banks can now decide on rates depending on their funding costs
• Applies to credit cards, overdrafts and pawning and advances
• Credit card interest rates expected to increase 35-40%

The Central Bank, making good on a policy promise made on April 8, removed rate caps applicable on select lending products in view of the sharp rise in bank lending rates and thereby allowed the banks to decide on their respective pricing of loans depending on the funding costs each one has. 

Accordingly the Central Bank last week issued a new order lifting caps on credit cards, all new pre-arranged temporary overdraft facilities and existing pre-arranged temporary overdrafts that are renewed or extended, and all new pawning advances and existing pawning advances that are 
renewed. 

The new rates would be applicable on credit cards from their next billing cycle and the banks are expecting the rates to climb to around 35 to 40 percent levels on cards, effectively making spending through cards prohibitive. 
The idea is to achieve demand restriction, which causes the current bout of inflation, according to the Central Bank officials.

However, as , lending rates are fast adjusting upwards since April 8 in response to the unprecedented 700 basis points hike, the monetary authority also renewed calls to, “adjust the deposit rates adequately, in line with the tight monetary policy measures adopted by CBSL, to attract deposits into the banking system,” said Yvette Fernando, who has been promoted to the post of Senior Deputy Governor, a post earlier held by the current Governor prior to retirement in 2020. 

Slow adjustment in the deposit rates compared to lending rates has been an issue since the beginning of the year as banks delay re-pricing of their deposits compared to their lending products. 

When the rates were coming down in 2020 and early part of 2021, banks did the reverse in order to benefit from timing differential in interest rates. 

This is how banks maintain and expand their margins, which lead to higher earnings. 

While rising interest rates are generally better for margins and thereby the earnings of banks, this time around the pace of rate increases is too intense that it effectively kills the demand for new loans and plunges many borrowers into default resulting in higher provisions and thereby non-performing loans.  Besides the removal of the rate caps in the said loan products, earlier in January the Central Bank removed the 7 percent maximum interest rate capped for the housing loans and tied it to the average monthly prime lending rate. 

In the week ended April 22, the weekly prime lending rate climbed 314 basis points to 14.20 percent.