Chile's central bank this year has cut its benchmark interest rate in an aggressive fashion to fight a slowing economy and rising unemployment. The last cut came earlier this month when the bank brought down the benchmark rate to 1.25% from 1.75%. The year has also seen the country's private sector banks come under heavy fire for not transferring the central bank's rate cuts to their own lending rates. To find out more about this controversial issue, BNamericas spoke with Francisco Castañeda, finance professor at Universidad de Santiago (Usach) and member of Usach's finance center.  

BNamericas: How important is the central bank's benchmark rate, when the country's private sector banks set their own lending rates?

Castañeda: The central bank benchmark rate is important when private sector banks determine their interest rates on loans with maturities of up to five years. So basically the benchmark rate has a big influence on consumer loan rates and a more limited impact on the cost of loans with longer maturities, such as mortgage loans. This year the country's private sector banks have been transferring the central bank's rate cuts to the public in a gradual fashion due to their greater risk aversion. Private banks have also cut their mortgage loan interest rates this year but probably not as much as the public had expected.  
Those rates depend to a great extent on the long-term interest rates on securities being traded on the local capital market. Those rates went down in the last quarter of 2008 and in the beginning of this year, but lately, they have been going up again, especially rates denominated in the UF inflation-linked unit, and to a lesser degree the peso-denominated rates. The rates increase is due to the view that investors have of the macro economic situation and what they expect will happen in the capital market going forward. For example, more corporate bond issues are expected in the domestic market, and maybe also a sovereign bond issue to help finance the budget deficit that Chile will record this year.  

BNamericas: Private sector banks have come under heavy fire this year for dragging their feet in terms of how fast they transfer the central bank rate cuts to their clients. Do you think the criticism of their interest rate policies has been fair?

Castañeda: When the central bank lowers its benchmark rates by more than 600 basis points in a few months, one could expect private banks to be a bit more aggressive in reducing their rates. However, we should not forget that the interest rates that private banks charge is a reflection of the risk in the business segments where they operate. Additionally, Chile's banks are not subject to the same pressures of the global credit crunch that banks in many other countries are, and their risk evaluation is more strongly linked to the deterioration of the country's productive conditions. And this has resulted in a higher-than-usual risk premium when they grant loans today.  

BNamericas: What kind of impact do you expect the government's pro-credit plan that was launched at the end of March to have on private banks and their interest rates?

Castañeda: That plan included a great number and a great variety of measures to boost competition in the credit market and to free up more resources for lending. Those measures will put a certain degree of downward pressure on the funding cost for private banks. It will take some time before some of the measures have an impact, and overall they represent a rather small percentage when measured against the financial system's total loan book.  

BNamericas: This year has seen BancoEstado play a very active role in lowering loan interest rates. What's your view on the state bank's growing importance in the financial system?

Castañeda: BancoEstado is a so-called first floor-bank, but this year it has almost acted like a second-floor bank. By this I mean that its aggressive interest rate policy has forced some private banks to follow suit, and that way, more credit has been granted by those banks. The interesting aspect of this is that BancoEstado has not pursued its objectives in a non-market way. Instead it has been done by increasing competition in the credit market by rapidly transferring the central bank's rate cuts to the public. BancoEstado has also played a very important role this year in ensuring that mortgage credit has continued to be available at reasonable terms for low and middle-income families. The government's subsidies have also contributed to this process of keeping mortgage credit flowing despite the crisis and the country's slowing economy.

Publicado en Business News America.