Without a doubt, banks are considered to be one of the most important institutions that have a great impact on the economy of any country. A well-established and efficient banking industry is essential for rapid economic growth as it is the industry that provides a system by which a country’s most important projects are funded.

Banks are financial intermediaries because they serve as a link between the savers and borrowers; they collect money from the savers (depositors) and lend it out to the borrowers at a cost. So, for the banks to perform well, they need to perform the lending function very well, thus the cost of lending (lending rates) determines the profitability of the banks. 

Since banks’ main source of revenues is through lending (interests earned on loans), the administration of the lending process is imperative for the bank's survival. The higher the lending rates, the more profits to the banks. However, higher lending rates have remained an issue of great concern to all major stakeholders in the economy. Lately, the high lending rates charged by the banks have raised many questions from policymakers. 

From a policymaker perspective, lower lending rates are desirable as they tend to have a positive influence on the investment environment. That is why we have seen the Government, through the Bank of Tanzania (BOT), take several monetary policy measures in the last few years to encourage the banks to lower their lending rates. 

Also, the president himself, President Samia Suluhu Hassan has been stressing the importance of banks to lend to the private sector at lower rates, as it has been argued by Economists that high interest rates are a barrier to economic development. 

The lending rate indicates how much it costs for businesses and individuals to borrow funds from the banks, hence it’s critical for the growth of our economy. Therefore, it is evident that the lending rate is crucial for the progress and development of the country, so it is important to understand what factors are affecting the lending rate. In this article, I will discuss the five factors that affect the bank’s lending rates:

Cost of Funds - This is the cost banks incur for collecting deposits from the public (borrowers and shareholders) and operational costs (staff salaries, benefits, overhead).  An increase in the cost of funds has been a key driver of the increase in bank’s lending rates. 

Lending is the main function of the banks and the main source of their revenue hence the lending rate must be higher than their cost of funds for them to make profits, and the higher the cost of funds the higher the lending rates. 

The Government, through BOT, has realized this and this is why it has taken several monetary policy measures to encourage the banks to lower their lending rates with no success. 

One of those measures is to lower their discount rate (the interest rate BOT is charging the commercial banks when lending to them) but still, the current overall lending rate of the banks is about 15.30 percent per annum Per Bank of Tanzania Monetary Policy Report of July 2024. 

With that being said, it is obvious that is not enough and the banks need to do their part by reducing their operational costs which will reduce their overall cost of funds. 

If BOT succeeds in lowering the cost of funds for banks, will that automatically lower the lending rates? Probably not, since there are other factors affecting the lending rates. Next week, I will discuss the remaining four factors affecting lending rates.

Kelvin Mkwawa (pictured), MBA is the seasoned banker based in Dar es Salaam. He can be reached through Email address: [email protected]