Tuesday, March 21, 2017

KENYA LENDING RATES CAP, LESSONS FOR UGANDA

Last week Kenyan banking giant Equity Bank released their results, which showed a drop in profitability due largely to increased provisioning for bad loans and a contraction of their loan book.

In 2016 net profit slid 4.1 percent to Kshs16.6b from Kshs17.3b the previous year mainly due to a loan provisioning that jumped almost three fold. Meanwhile the loan book also shrunk 1.4 percent.

The increased incidents of bad loans maybe due to a general slowing down in the economy but the reduction in their loan book was due mainly to a law, capping lending rates passed late last year.
Under the law bank lending rates were capped at four percentage points above the Central Bank Rate (CBR). So at the time of enacting the law the CBR was at 10.5 percent so banks can not lend at a rate higher than 14.5 percent.

"This was a classic case of political expediency trumping good economic sense. If the government – the safest debtor around, is borrowing from the public at more than 10 percent how can a bank account for costs and margin within such a narrow range?...

So what banks have done in Kenya, they are in the process of winding back on their lending to all but the biggest SMEs, the most prime corporates and the government. It would be foolhardy to do otherwise.

The effect on the economy will be an inevitable slow down, as businesses have to cut back on their operations, because they cannot sustain them or scale up, on one hand and because the demand in the market has fallen off, as people have less cash on hand.

If a country wants to cut its lending rates, without subverting the laws of supply and demand, it can do two things; reduce the government’s cost of borrowing, since all lending is pegged to that and secondly, raise its level of saving.

Banks make their money by lending. Money seating in the vaults is a cost. With too much savings and wanting to minimise their costs, they will be forced to lower their lending rates and ship out the money.

Political pronouncements are just playing to the gallery. Expectations are that after the August elections in Kenya, there will be a move to reverse the law.

On the other hand despite the clumsiness of the Kenyan MPs, they were responding to a genuine frustration with the banking sector that we can relate to in Uganda.

On a micro level that lending rates are too high despite the fact that inflation is largely under control and interest on deposits are low.

As if that is not enough when everybody else is struggling with the economy, banks seem to enjoy a continuous purple patch.

"High lending rates are a symptom of larger problems, not least of all that there is little to no effort, to direct lending towards the productive sectors and away from consumption...

If bank lending was directed towards agriculture and manufacturing rather than towards personal loans and real estate speculation, incomes would rise more evenly across the economy, raise saving rates and drop lending rates.

In Japan, South Korea, Taiwan and now China banks were “incentivised” to lend to agriculture and manufacturing.

In agriculture this has meant that these countries are largely food sufficient. This means they save precious hard currency they would have used in importing food but also raise rural incomes which provide the initial demand for manufactured goods, serving as a bed rock on which those respective countries industrialisation was based.

In manufacturing preferential credit was extended to the exporting companies at rates which would allow them to be competitive abroad.

Interestingly when many of these manufactures could break away from government oversight – the beneficiaries of the credit were those who supported government industrial policy, they went to the open market to raise cash by listing or offering bonds deepening their financial markets. A kind of unintended consequence.

"The reason why such policies would be unpopular in the region is because one, they would mean
lower margins for banks and secondly, it would mean even higher borrowing rates for consumption, as more and more money is shovelled at infrastructure, manufacturing and agriculture, which may become politically uncomfortable...

But one day somebody is going to have to bite the bullet. Take the political risk to ignore possible push back from the urban elite, who gouge on cheap credit to fund merrymaking and speculation.

Such a shift in policy will give the rural farmers a chance to raise their incomes, create jobs in manufacturing, boost exports and speed up the attainment of a more equitable middle income nation status. Not one where most of the resources are controlled by a minority of the population while the majority live as second class citizens.

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