Cost of capital holds back growth of businesses in East Africa

The high cost of capital is making doing business in East Africa difficult, limiting investment and undermining economic growth. TEA GRAPHIC 

By BERNA NAMATA The EastAfrican

The high cost of capital is making doing business in East Africa difficult, limiting investment and undermining economic growth.

 

This is because banks not only prefer to lend to governments — which they consider less risky — but also charge relatively high interest rates, making it difficult for the private sector to borrow.

According to the Economic Development in Africa Report 2014 of the UN Conference on Trade and Development, most banks in Africa tend to hold excess liquid reserves in the form of government securities rather than lend to the private sector for productive investment.

This is partly due to the perceived risk of borrower default as well as precautionary motives such as the need to safeguard against unexpected withdraw, according to the report.

“While African governments encourage banks to lend to the private sector, the interest rate on government bonds is often so high that banks have no incentive to lend to the private sector,” the report says.

In Nigeria, for example, the interest rate on government bonds is often as high as 12 per cent, creating an incentive for banks to hold government instruments rather than lend to the productive sectors.

According to Eric Rutabana, chief investment officer of Business Partners International Rwanda, commercial banks prefer to invest in government securities to minimise the risk of default.

“Commercial banks want to recover their loans on average in five years because they have short term deposits. This is why they prefer to invest in government Treasury bills,” Mr Rutabana said, adding that there is a need for specialised financing institutions such as equity funds and development banks to support lending to the private sector.

The report “Catalysing Investment for Transformative Growth in Africa” shows that average spreads in interest rates — the difference between lending and deposit rates — were at an average of 9 per cent in sub-Saharan Africa in 2011, compared with 5 per cent in East Asia and the Pacific.

The report shows that interest spreads from 2009 to 2011 in Uganda were in excess of 10 per cent while in Kenya they were at 9.4 per cent during the same period. In Tanzania, interest spreads were estimated at 7.7 per cent.

“Fixing the problems in the banking sector should be a priority — in all the enterprise surveys across the region, the lack of access to credit is either the first or second major constraint for business development,” said Andrew Mold, a senior economic affairs officer at the Kigali based Sub-regional Office for Eastern Africa (SRO-EA) of the United Nations Economic Commission for Africa.

“Banks everywhere like to deflect criticism, saying it is due to market conditions and the like, but I think the evidence is fairly resounding,” Mr Mold said.

The report also shows that commercial banks in Africa tend to focus their lending on high turnover activities such as commerce and consumer loans to the detriment of productive activities.

For instance, in Kenya, while consumer loans or household personal loans accounted for 24.6 per cent of loans in 2012, which is well above the 4.9 per cent to agriculture, 13.5 per cent to manufacturing, the rate of bad loans or non-performing loans was high in consumer loans at 33.2 per cent.

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