Tuesday, September 13, 2016

OF CAPPING LENDING RATES AND MARKET FORCES

As if by clockwork once our Kenyan brothers passed into law a bill to cap commercial bank lending rates, we started falling all over ourselves to copy them.

Kenya’s President Uhuru Kenyatta signed into law the act which caps lending rates at four percentage points above the Central Bank of Kenya’s indicative rate, which stands at about 10.5 percent currently.

The champions of this cause in Uganda, Civil Society Budget Advocacy Group (CSBAG) went one better than the Kenyans, not only calling for five percentage point cap above the Central Bank Rate (CBR) for lending rates but also calling for deposit rates to be raised to 50 percent of the CBR. The CBR in august was announced at 14 percent.

With one fell swoop they intend to lower bank revenues while increasing their cost of money, a major element in the cost of their doing business!

"For anyone with even a rudimentary knowledge of business this is a preposterous proposition. But we all know how when even the most reasonable things come up against politics – anywhere in the world, things can go south...

We all agree that lending rates in this country are ridiculously high. What kind of business, playing according to all the rules can manage to repay the banks at 30 percent and still make a decent return? 

Maybe only the banks and the drug pushers!

So therefore you will not find any arguments for a continuation of the status quo.

Where proposed solutions differ is how we go about it.

Understandably we reach for the easy solution. Mobilise the politicians to pass a law that caps lending rates and voila! All will be well.

But like in many other such dilemmas the more sustainable route to resolution would cost us too much, in terms of personal comfort, take longer to show results and will just not serve our purpose to play to the gallery and posture as the champions of the masses.

Neither in Kenya nor in Uganda is there any explanation of how we come to the cap rate. As best we can see it is an arbitrary number pulled out of a hat without any thought to the reality.

The reality should be based on how banks determine lending rates.

Like any other businessmen they consider their costs, which in this case include how much they pay depositors, the risk of default by lenders, at what rate the government is willing to borrow and finally their own margin. Something like that.

The argument has been made often that for the low rates banks pay on deposits – you will be lucky to get 3 percent, they should charge lower for loans. But we also know that their fixed deposits attract as much as 14 percent in some incidents, raising the cost of their money.

This is before you factor in the cost of running the huge branch networks and ATMs, we demand as customers, the huge salaries and bonuses they pay their managements and the profits they need to repatriate in dollars to their shareholders.

Then the government – the safest bet around is borrowing in double digits. The benchmark 91-day treasury bill goes for 14.92 percent, this the rate to which banks look to price their loans.

"If I lend the government, which is not going anywhere, at 15 percent what is the realistic rate I should lend to a person who can die, relocate or get fired from his job? Twice? Three times as much?..

Some people argue that government should be borrowing at five percent, given how they are such a sure bet. But we know that even governments have a risk of default attached to themselves. You will not lend to the Swedish government at the same rate as you would lend to Kampala.

Politics may prevail and try to straight jacket the banks. And the banks will react by cutting their costs – reduce branches, cut staff, lend less and discourage deposits!

People forget that there was a time when banks had only one branch in the whole country, would not touch a loan application unless it was backed by a land title in Kampala and penalised you for saving by mandating high minimum balances. And they were still profitable.

So how do we sustainably reduce lending rates?

To begin with government has to cut back on its borrowing from the public. That means it has to cut back on its own budget by reducing on its education, health and infrastructure projects, its district creation drive and on corruption among other things. Easier said than done, but also detrimental to the country’s long term development agenda.

Lower government costs would mean that it wold borrow less from the public, which would lower the treasury bill and bond rates, preferably below double digit rates.

Banks too will have to re-examine their overheads, do they for instance need the big banking halls they maintain? The size of the banking hall used to be a sign of the bank’s credibility are we impressed anymore? Do we need banking halls anymore when we can do financial transactions off our mobile phones?

"As a way to lower the cost of repatriating profits there is urgent need for a credible, dominant local bank, which by sheer force of its size would lower lending rates industry wide. Our government has failed us in this and our businessmen can’t seem to muster the discipline required to achieve this, but it is something that has to be contemplated...

My challenge with all these calls for capping of lending rates – copycat or otherwise, is that they display a lack of understanding or ignore all together the forces of supply and demand at play.


You cannot play a rugby using hockey rules. You need to know the rules of the game you are playing before you can play, or even break the rules!

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