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

Defining the Gravity of the Problem

Real lending rates have always been among the highest in Central and Eastern Europe
Real lending rate (nominal minus GDP deflator), average 2005-2010, %
GEO ALB MDA AZE HRV ROM CZE HUN SVK SVN BGR MNE BIH LTU LVA EST RUS UKR BLR -5 0 5 10 15

Source: World Bank

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
MNE BGR SVK EST CZE AZE POL GEO LVA ROM HRV RUS HUN SVN MDA LTU ALB BIH UKR 0 20 40 60 80 100 120 140

Source: World Economic Forum

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, %
Bank loans to GDP Nominal lending rate 40.2 32.0 Real lending rate 39.8 41.6 38.0

45
40 35 30 27.5 29.1

34.5 31.5

33.9

29.5

25
20 15

25.2

10
5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (e)

Source: National Bank of Moldova and own calculations

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

Main reasons of this discrepancy

1. Firms are more creditworthy as they are able to provide more collateral; 2. The strong spike in the share of nonperforming loans in total banks credits was mainly driven by consumer loans; 3. Central banks credit facility which provided access to long-term loans at preferential interest rate

The Main Credit Costs Determinants

The Main Components of Lending Interest Rates

Factor no. 1: High Costs of Financing

Real Deposit Interest Rates, average 2005-2010, %
MDA ALB GEO HUN SVN AZE CZE LTU BIH EST HRV MNE ROM BGR LVA BLR -5 -3 -1 1 3 5

Source: World Bank

Factors driving up the costs of financing banks balance sheets

1. Low level of disposable income in Moldova which limits households savings; 2. Limited confidence in Moldovan banks; 3. High macroeconomic uncertainty; 4. 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

Bank liquid reserves to bank assets ratio (%)

SVK ROM MDA HRV ALB CZE AZE GEO RUS HUN BGR POL BLR SVN EST LVA UKR LTU 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45

Source: World Bank

Factor no. 2: Poor Competition and Low Banking Sector Efficiency

Share of foreign owned banks' assets in total banking assets, 2010, %

Source: EBRD

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)

Factor no. 3: High Risk Premiums

Risk premiums on lending (lending rate minus T-bills rate)
GEO AZE ROM MDA

MNE
ALB

BGR
LVA CZE SVN LTU

HUN
POL 0 5 10 15 20

Source: World Bank

Main causes fueling the risk premiums

Macroeconomic instability amplified by political instability, especially starting in 2009 and continuing onwards. Poor lenders rights and burdensome procedures for collateral execution which favor the debtor. Absence of well-functioning credit information (history) bureaus. Poor management of most companies applying for bank credits and low quality credit applications. Maturity mismatch problem

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, %
MDA ROM MNE LTU POL LVA ALB HRV RUS BIH HUN SVK BGR CZE GEO BLR EST SVN 0 2 4 6 8 10

Source: World Bank

Central Banks Action to Reduce the Lending Interest Rates

Three important notes

1. The reduction of credit costs is not the primary prerogative of the National Bank of Moldova (NBM) due to its IT strategy. 2. NBM has a very limited range of instruments which could be used for making interest rates more affordable. 3. NBM is a net debtor of the banking system and not a net lender.

Main instruments used:

1. Monetary policy inertia: NBM adjusts its policy rate to macroeconomic news very slowly; 2. Keeping an accommodative monetary policy stance; 3. Long-term credit facility for commercial banks 4. In 2011, NBM set the required reserves rate at 0% for deposits with maturities longer than two years.

Outcomes of High Interest Rates Problem

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

Poor intermediation function of commercial banks due to:

1. shrinking demand for loans due to their low affordability 2. 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.

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

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 Moldovas 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.

Thank you!