Savers, beware of high interest rate offers!

Wednesday, 27 May 2015 00:01 - - {{hitsCtrl.values.hits}}

By W.A. Wijewardena

A top public servant recently contacted me and asked for my advice. He named a financial institution and said that it had offered him a very attractive interest rate if he shifts his deposits to that financial institution. “I can’t refuse that offer,” he said. “It’s about 10% higher than the rate that I get now.” He wanted to know whether he should shift his deposits to that financial institution.

I don’t blame him for being attracted to high interest rates offered. When the market interest rates are low due to the low interest rate policy of the Central Bank, it is natural for savers to look for avenues to compensate for the loss of interest incomes. The sad side of the story is that his gullibility is smelled by crafty schemers who try to hook him to their imprudent schemes by offering him irresistible high rates. Thus, an undesired consequence of low interest rate policies is to deliver the gullible savers to fake financial institutions.

It happens due to excess greed of savers overshadowed by financial illiteracy. Charles Ponzi who defrauded millions of gullible Americans in early 20th century by getting them to invest in discounted international postal coupons to become quickly rich is reported to have said when asked him why he did so, “If people want to be cheated and if I don’t cheat them, someone else would do so.”

How to protect the savers from becoming prey to crafty schemers? There is only one way to do so. That is to educate them continuously on the possible perils of becoming associated with high interest offering financial institutions. Savers should be taught to ask one simple question. That is, why can’t the financial institution in question mobilise savings at the prevailing market rates? The answer is that its financial credentials are not trusted by the majority of savers and therefore, it can’t mobilise deposits at the prevailing rates. Hence, it has to offer a higher rate than the rates prevailing in the market. Then, there is another question that can be asked by savers. That is, having borrowed from them at high rates, at what rate could the financial institution in question lend such money and ensure that the savers are promptly repaid. If the general interest rate structure in the country is low, anyone who can’t borrow at the prevailing low rates is a risky customer to a lending institution. Hence, there is a strong likelihood that the lending institution offering high rates to savers will default interest payments because its borrowers will default their loans. Hence, savers should caution themselves when high interest offering institutions or their agents approach them for deposits.

Thus, the rule for the saver is clear. That is a modification of the Latin saying ‘Caveat Emptor’ or let the buyer beware. When applied to savers, it says that ‘Let the saver beware’. In other words, the saver has to make all the relevant inquiries about the financial institution in question and make a judgment by himself whether he should deposit his savings with it or not. If he doesn’t do so, he alone has to bear the loss of his savings due to fraud or maladministration in financial institutions. He can’t pass that responsibility to the Central Bank or the Government.