Everywhere in the world the lending rates, account commissions, fees, and charges that financial institutions fix are determined chiefly by two factors:
- The rules, policies, regulations, and rates of the Central Bank; and
- the market position of the competition.
a.
- Central Banks or the Federal Reserve Bank (as it is called in the United States of America are the chief administrators of interest rates. This is no different in Ghana. By policy, the Central Bank fixes what is referred to as discount rates. When commercial banks in Ghana go to the Central Bank to borrow funds, it usually comes at a particular interest rate known as the discount rate.
- Commercial banks, in turn, lend these funds to their customers at a rate that is higher but NOT LOWER than the Federal Reserve Bank's discount rate.
- Banks make a profit when they take up these funds at a lower rate than the Federal Reserve Bank and lend it to customers at a higher rate.
- Banks also borrow funds from customer deposits. They borrow from these deposits and give loans to other customers. They also turn a profit when the rate at which they borrow from customer deposits is higher than the rate at which such funds are paid back to them by the borrowers. This net difference (profit to the bank) is called Net Interest Margin.
- Therefore, in setting lending rates, the discount rate of the Central Bank must be factored into consideration.
b.
So banks can arbitrarily charge any rate above the central bank's discount rates, that they can lend funds to consumers. However, they must take into consideration the actions of other banks. If other banks are giving out loans are a 5% margin above the Central Bank's discount rate, to fix a higher margin may translate to not being able to get customers at all to take up their loans.
c.
Commercial banks must also take into consideration the Central Banks reserve requirements.
In simple terms, Reserve Requirements is the mandatory percentage of its cash that a commercial bank or financial institution must keep with the Federal Reserve Bank.
This requirement and the discount rate are collectively called Monetary Policy tools. The higher the reserve, the lower the amount of cash available for lending by the financial institution.
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