2021-01-21 08:15

Lending to the Private Non-Financial Sector: Current Interest Rates Trends

A survey conducted by the Bank of Lithuania revealed that interest rates are the most significant factor when decisions regarding borrowing are made. With this in mind, it’s important to understand the current interest rate trends throughout various segments of the Lithuanian private sector.

Considering that Monetary Financial Institutions (MFIs) are the main source of household financing and are also important source of finance for businesses, the dynamics of their interest rates will be reviewed further.

Despite turbulent times interest rate volatility in Lithuania is low

Theoretically, COVID-19 and the resulting economic slowdown should have increased the demand for liquidity, as well as inflating interest rates. However, this was not the case. According to the Bank of Lithuania, over the last three years, the average interest rate for new loans provided by MFIs to private businesses in the non-financial sector remained almost unchanged.

In November 2020 the interest rate stood at 3.30%*. This was only 0.05 p.p. less than year ago and 0.40 p.p. higher than three years ago.

The most likely reason as to why interest rates haven‘t increased significantly is that demand for loans was much lower than expected. Businesses either postponed their investments or tried to find alternative financing sources.

For example, many businesses turned to funding sources such as governmental subsidies or their own parent companies, while households decreased spending by reducing their level of consumption. In addition to these factors, it’s also interesting to note that increased competition in the banking sector and pressure from fintechs slowed the growth of lending pricing.

However, due to the pandemic and economic instability, lenders’ credit risk and non-performing loans both increased. This meant that there was also no room for a significant decline of interest rates. Therefore, such trends created a counterbalance in pricing behaviour.

The dynamics of interest rates in business and retail sectors is different

Statistical data also indicates that interest rates to non-financial corporations did not change significantly over the year. In November 2020, the average was 3.04%*, which was just 0.04 p.p. higher than year ago.

However, over the last three years interest rates to businesses increased by 0.74 p.p. There were several reasons for this movement in interest rates. Firstly, it’s important to note that about 97% of Lithuanian companies belong to the SME sector, which usually has much higher credit risk when compared with large corporations. Due to COVID-19 this risk increased even more. Additionally, several large banks have exited the Lithuanian market, while their customers flocked to other large banks. As a result, the remaining banks in the Lithuanian market have tightened credit conditions imposed on their weaker customers.

The household sector is quite different. Despite the impact of COVID-19 and slower economic growth, the housing market in Lithuania is booming and mortgage loan portfolios of Lithuanian MFIs shows some of the fastest growth in the EU. This being the case, interest rates have not changed over the year (-0.02 p.p., to 2.37%*) and over a three-year period increased only by 0.36 p.p. The main reason for this stagnant growth is also related to the large amount of competition among the banks offering these products.

Conversely, the consumer loan sector had the highest interest rate volatility. In November 2020 the average interest rate for consumer loans was close to 8.59%* (i.e., 2.90 p.p. less than three years ago). As stated previously, due to COVID-19 many households decided to reduce their consumption. In addition, new consumer lending providers are entering the market, and this has pressured MFIs to reduce their pricing.

Stable interest rates affect MFIs interest income positively

Despite the fact that interest rates are not experiencing any significant growth, MFIs’ income has not been negatively affected. Statistics show that interest rates on outstanding loans are increasing across all sectors. The highest growth is fixed in the corporate and mortgage sectors. In these sectors, during the last three years, interest rates have increased by 0.36 p.p. and 0.26 p.p. respectively (2.47% and 1.88%*). This means that amortization of old loans which have low interest rates has an impact.

It is difficult to predict where lending prices will move in the future, however, taking factors such as increasing competition in the banking sector, fast development of fintechs and European Central Bank monetary policy into consideration, larger fluctuations in the short term should not be expected.

*12-month simple moving average