Central Bank's discount rate and Lombard Bank's profits

Many readers might not have made any connection between two news items appearing in the same edition of The Times (Saturday, December 21) but I found their publication on the same day somewhat intriguing. I refer to the news that the Central Bank had reduced its discount rate by 25 basis points and to the report on Lombard Bank's annual general meeting when it was revealed that Lombard had made a record Lm1.41 million pre-tax profit.

My rudimentary knowledge of economics leads me to understand that when the Central Bank reduces its discount rate, it is in actual fact reducing the cost of borrowing money - a step taken so as to discourage hoarding, encourage lending and hence make investment more attractive and worthwhile. Obviously a decision for such a reduction is taken by the Central Bank when it takes into consideration the economic situation prevalent at the time. Of course, there are other scenarios when the Central Bank feels it ought to raise the discount rate to make lending more expensive.

In a liberalised economy, one should therefore logically expect that commercial banks lower or increase their interest rates in line with the Central Bank's decisions on its discount rates. Otherwise the intentions of the Central Bank's decisions would not be achieved!

The Water Services Corporation has hefty overdrafts with a number of commercial banks and has not only benefited financially from the renegotiation of the conditions of these loans but also from the decrease in interest payable as a result of the Central Bank's decisions to lower its discount rate.

There was, however, one notable exception to this general trend - Lombard Bank with whom the WSC had a loan to the tune of Lm2 million. When the WSC queried why the interest rates on this overdraft were not being adjusted in line with the Central Bank decisions on the discount rate, Lombard Bank's official reply was that the discount rate referred to in the loan agreement was its own (Lombard's) discount rate and not the Central Bank's and this discount rate had not been lowered in line with that of the Central Bank!

The wording referred to, in fact, did refer to the bank's discount rate and not to the Central Bank's discount rate and therefore, from a strictly legal point of view, Lombard Bank was acting correctly.

To me, however, the upshot of this interesting, selective use of words seems to be that Lombard Bank has found a legal way how to undermine the Central Bank's efforts to reduce the cost of borrowing money! In this way, the Central Bank's decision to reduce its discount rates leads only to an increase in the bank's profits - an end result that was certainly not the raison d'etre of the Central Bank's decision.

In view of this absurd situation, the Water Services Corporation has decided to end its facilities with Lombard Bank and move the loan to other commercial banks that deal with their customers in a fair and just manner.

In the circumstances, I feel I ought to recommend companies and entities using - or considering using - Lombard Bank's lending facilities to check the written conditions under which this bank lends money so as to ensure that when the Central Bank reduces the cost of borrowing money, they - and not the bank - benefit from such reductions.