The impact of interest rate on the demand for credit in Ghana

• Author: Ishmael Ali Esson,Darko Vuković,Moinak Maiti
• DOI: http://doi.org/10.1002/pa.2098
• Date: 01 August 2020
• Published date: 01 August 2020

ACADEMIC PAPER

The impact of interest rate on the demand for credit in Ghana

Moinak Maiti

1

| Ishmael Ali Esson

2

| Darko Vukovi

c

3

1

Department for Finance, St. Petersburg

School of Economics and Management,

National Research University Higher School of

Economics, Sankt Petersburg, Russia

2

Department for Finance, St. Petersburg

School of Economics and Management, Higher

School of Economics, National Research

University, Sankt Petersburg, Russia

3

Finance and Credit Department, Faculty of

Economics, People's Friendship University of

Russia, RUDN University, Moscow, Russia

Correspondence

Moinak Maiti, Department for Finance,

St. Petersburg School of Economics and

Management, National Research University

Higher School of Economics, Kantemirovskaya

St. 3A, Sankt Petersburg 194100, Russia,

Email: mmaiti@hse.ru

This article investigates the impact of financial liberalization on the demand for credit

in Ghana. It contributes by making suggestions pertaining to questions on the effec-

tiveness of interest rate liberalization in driving private sector demand for credit both

in the short and the long-run, as well as the speed of adjustments to equilibrium after

the implementation of the financial liberalization programme. The study results indi-

cate that interest rate has no significant impact on the demand for credit both in the

short-run and long-run. Moreover, inflation has a negative significant effect on the

demand for credit in the short-run. The results also suggest that about 66% of dis-

equilibrium from the preceding year is corrected in the current year. However, these

findings seem to indicates that the financial market in Ghana is not fully competitive.

The oligopolistic and noncompetitive financial system may be attributable to the

extreme minimum capital requirement and the emerging consolidation of commercial

banks through government takeovers as well as the various credit rationing practices

by banks aimed at reducing the risk of adverse selection and insolvency.

1|INTRODUCTION

Credit creation is an instrumental tool in driving economic forces of

liquidity, wealth creation and more generally, economic stability

(Stiglitz, 2017). Modern capital financing relies heavily on the access

to loans and the use of debt in creating wealth and also as a conve-

nient way of generating extra value to investors since interest pay-

ment is tax deductible. Authorities of most advanced and developing

nations on many occasions had resorted to the use of monetary poli-

cies that are oriented toward the control of cyclical economic fluctua-

tions. However, to achieve the goals of credit creation, formal

financial institutions plays a defining role in the way capital is made

available for rent. Over the past years, governments of many develop-

ing nations had championed policies (Maiti, 2018a) directed at

enhancing accessibility to credit, particularly to small scale businesses

and to a larger extent the continual advocacy of financial inclusion

(Maiti, 2018b) of which Ghana is no exception. However, the discre-

tionary features of commercial banks and the persistent intervention

of government in decisions concerning financial markets and the way

financial institutions allocate credit often results in inefficient market

outcomes (McKinnon, 1973). In efficient markets where asset prices

reflect the current state of market information, resources are allo-

cated by the forces of demand and supply, but in situations where the

fundamental theorem of perfect markets are violated, the concept of

market efficiency may appear far-fetched (Mansfield & Yohe, 2004).

According to Stiglitz and Brown (2000), when the fundamental theo-

rem of welfare economics does not hold, the market is imperfect and

would not produce the most efficient outcomes and allocations on its

own. This seems to explain the hypothesis of McKinnon (1973) and

Shaw (1973) on the reasons for the low capital mobilization and credit

creation in developing countries despite higher levels of interest rates.

The pivotal role of interest rate in the allocation of credit in imperfect

financial markets had been a topic of debate among a diverse eco-

nomic school of thoughts. The general proposition of the monetarist

school of thought regarding the crowding out effect of higher interest

rates on private sector investment has been a remarkable subject of

interest in the allocation of financial resources. The monetarist

“crowding out”analogy seems to reconcile with the widely known

theoretical framework of McKinnon (1973) and Shaw (1973) which

hypothesized that a low-interest rate is a disincentive to savings,

resulting in a reduction in the availability of credit for investments.

According to McKinnon (1973), this situation of financial repression

can be mitigated through the liberalization of the financial sector. This

liberalization policy, if effective would foster interest rates that are

determined by the forces of demand and supply and would conse-

quently induce efficient outcomes in which the real and nominal

Received: 10 December 2019 Revised: 22 December 2019 Accepted: 14 February 2020

DOI: 10.1002/pa.2098

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https://doi.org/10.1002/pa.2098