The Problem of Interest Rates in the Republic of Moldova

1. The Problem of Interest Rates in the Republic of Moldova Analytical Country Report Adrian Lupusor Head of Monetary Sector Department “Expert-Grup” economic think-tank email: adrian@expert-grup.org phone: +373 22 536859

2. Defining the Gravity of the Problem

3. Real lending rates have always been among the highest in Central and Eastern Europe Real lending rate (nominal minus GDP deflator), average 2005-2010, % Source: World Bank

4. Access to financing is identified as one of the most problematic factors for doing business Ease of access to loans ranking, Global Competitiveness Index 2011-2012 Source: World Economic Forum

5. Though much lower than pre-crisis levels the difference between nominal and real lending interest rates denotes a strong inflationary environment The share of bank loans to GDP, nominal and real interest rates for bank credits in national currency, % Source: National Bank of Moldova and own calculations

6. Lending interest rates have traditionally been higher for households than for firms Monthly lending interest rates, average, for credits to companies and households, % Source: National Bank of Moldova

7. Main reasons of this discrepancy • Firms are more creditworthy as they are able to provide more collateral; • The strong spike in the share of non-performing loans in total banks’ credits was mainly driven by consumer loans; • Central bank’s credit facility which provided access to long-term loans at preferential interest rate

8. The Main Credit Costs Determinants

9. The Main Components of Lending Interest Rates

10. Factor no. 1: High Costs of Financing Real Deposit Interest Rates, average 2005-2010, % Source: World Bank

11. Factors driving up the costs of financing banks’ balance sheets • Low level of disposable income in Moldova which limits households’ savings; • Limited confidence in Moldovan banks; • High macroeconomic uncertainty; • Poor spectrum of saving instruments. Poor access to long-term resources => maturity mismatch => banks are forced to keep their balance sheets as liquid as possible

12. Bank liquid reserves to bank assets ratio (%) Source: World Bank

13. Factor no. 2: PoorCompetitionandLow Banking Sector Efficiency Share of foreign owned banks' assets in total banking assets, 2010, % Source: EBRD

14. Moldovan banking system is one of the most inefficient in the region Profit Efficiency Scores in Central Eastern Europe, 2008 Source: Lupusor and Babin (2011)

15. Factor no. 3: High Risk Premiums Risk premiums on lending (lending rate minus T-bills rate) Source: World Bank

16. Main causes fueling the risk premiums • Macroeconomic instabilityamplifiedby political instability, especiallystarting in 2009 andcontinuingonwards. • Poorlenders’ rightsandburdensomeprocedures for collateralexecutionwhich favor thedebtor. • Absenceof well-functioning credit information (history) bureaus. • Poor management of mostcompaniesapplying for bankcredits and low quality credit applications. • Maturity mismatch problem

17. Consequence: The of banking loan portfolios in Moldova has traditionally been one of the highest among the region Share of non-performing loans in total gross loans, average 2005-2010, % Source: World Bank

18. Central Bank’s Action to Reduce the Lending Interest Rates

19. Three important notes • The reduction of credit costs is not the primary prerogative of the National Bank of Moldova (NBM) due to its IT strategy. • NBM has a very limited range of instruments which could be used for making interest rates more affordable. • NBM is a net debtor of the banking system and not a net lender.

20. Main instruments used: • Monetary policy inertia: NBM adjusts its policy rate to macroeconomic news very slowly; • Keepingan accommodativemonetarypolicystance; • Long-termcredit facility for commercialbanks • In 2011, NBM set therequiredreserves rate at 0% for depositswithmaturitieslongerthantwoyears.

21. Outcomes of High Interest Rates Problem

22. The main outcome: narrow access of firms and households to banking credits The share of bank credits in GDP, average for the period 2005-2010, % Source: World Bank

23. Poor intermediation function of commercial banks due to: • shrinking demand for loans due to their low affordability • banks’ preference to lend to companies with better credit histories SMEs are strongly disadvantaged: whereas SME sector account for about 98% of the total number of enterprises and 59% of total employment, it received only 31% of total banking loans in 2010.

24. Paradox: high liquidity levels paralleled with low banking sector penetration Correlation between the banking liquidity and the share of banking credits in GDP, average for the period 2005-2010, % Source: World Bank and own calculations

25. The Global Competitiveness Index confirms the lending rates issue in Moldova • Access to financing is constantly recognized as one of the most problematic factor for doing business in Moldova • Moldova’s rank according to the ease of access to loans, in fact, decreased in comparison with the pre-crisis level: 102nd place out of 134 according to the 2008-2009 issue, compared to 109th place out of 142 in the 2011-2012 issue.

26. Thank you!