Sri Lanka central bank to develop a cost-based rate to price loans

ECONOMYNEXT – Sri Lanka’s central bank said it was developing a cost based benchmark interest rate to price loans, hoping unusually that it will improve competition.

“Establishing a sound benchmark interest rate for the banking sector, which reflects actual cost of funds, has become vital given the deficiencies of the existing benchmark interest rates,” the central bank said in a roadmap for monetary policy in 2020.

“The Central Bank intends to set up a task force with the participation of relevant stakeholders to introduce an appropriate cost reflective benchmark interest rate for pricing loan products.

“We believe that this measure will improve healthy competition among banks, while supporting efficient transmission of monetary policy measures.”

It is not clear how cost-based pricing will improve competition as the key drawback of cost-based pricing is that it ignores that there is competition as rookie business studies students learn.

With competition eliminated, the regulator then has to set targets to bring costs of various components down as is done in telecom, power cost based pricing.

Costs can differ widely from bank to bank, based on how inefficient, or overstaffed each bank is. Any cost based pricing would eliminate the need to cut costs due to competition, a key problem with formula based pricing.

There have already been complaints that high costs of state banks, which command large shares of deposit and loan markets is a reason for high nominal rates.

Sri Lanka has high and volatile interest rates, a phenomenon common in countries with monetary instability and currency depreciation.

Sri Lanka’s central bank last year killed competition in deposit markets by forcing banks to artificially bring down rates on the threat of punitive action after destroying the real value of customer deposits through currency depreciation.

Analysts have called for monetary reform either in the form of consistent peg, or a genuine floating rate, which will end balance of payments trouble. (Colombo/Jan08/2020)