COVID-19 has generated noteworthy high volatility and instability in global capital markets including Asia. The low loan interest rate picture is dropping the core banking productivity in fully grown markets.
Thus, financial associations are changing towards commission-based profits from the likes of the tech businesses and the payments.
The central bank of China has cut the interest rate on its medium-term line of credit recently, following paralleldrops to borrowing costs in other liquidity tools in recent weeks to backing the economy.
In theory, the reduction in the rate charged by the banks to financial institutions means that they reduce the interest they charge their users. This encourages companies and individuals to acquire credit and increase their level of spending, which in turn boosts production and employment.
However, many economists have doubts about this strategy: some consider that the road between the cuts in central bank rates and the economic recovery is so long and uncertain. That, in difficult times, the call to save the situation is not the monetary policy but fiscal policy, that the government spends and distributes subsidies directly.
In practice, the reduction of the bank interest rate can be seen as an obstacle course, because at each stage of the process difficulties may arise that prevent its continuity or reduce the effects sought.
The process that goes from the decision of the banks to the improvement in the growth rate depends on the decisions of economic agents of a very diverse nature: the financial system, producers, consumers, and the external sector.
In a scenario of high uncertainty such as the current one, banks fear a portfolio deterioration if they do not select their debtors very well, which leads them to limit the supply of loans. For its part, the demand for credit is held back because, in many cases, the expected profitability of the project in which the resources are to be used is so low that it is lower than the loan rates.
So, many of the medium and small companies – which are the ones that need the most support – could not access loans, because the banks denied them or set very high-interest rates, due to the very high risk they represent.
Will it serve to reactivate the economy?
The rate reduction policy will likely continue in the future, with a long-term purpose: to support economic recovery.
In that case, the unknown has to do with the destination of the resources obtained on loan. Many opportunities are likely to emerge for businesses that have managed to survive the pandemic and for those that take advantage of the new fields opening up in e-commerce.
Possibly, as commerce, restaurants, and travel begin to normalize, consumer credit will help these sectors to recover thanks to the increased use of credit cards.
So, the one from increased spending to increased production and employment – depends on many factors. The rebound in economic activity will be greater to the extent that investment spending is directed to activities with significant production chains in the domestic economy and with a good capacity to generate employment.