How oil and banking sectors failed litmus test in liberalised economy

Consumer Federation of Kenya activists push for rates cap last week. PHOTO | DENNIS ONSONGO 

By GEORGE WACHIRA

In Summary

• Oil and banking sectors cashed in on lax regulation at expense of the public interest.
• A free market economy pre-supposes that sector systems have effective checks and balances, and that markets are efficient and with adequate capacity.

Interest rate capping followed the market liberalisation that happened in the early 1990s was probably hurriedly done without sufficient in-built provisions to ensure effective market competition and consumer protection.

A free market economy pre-supposes that sector systems have effective checks and balances, and that markets are efficient and with adequate capacity.

After liberalisation, this was apparently not the case with the downstream petroleum marketing and banking sectors. Oil price regulation had to be re-introduced in 2010 while previously liberalised interest rates were re-capped last week. For the two sectors the free market intentions may have failed for very similar reasons which I will analyse below.

Post liberalisation, the sector regulatory agencies which were meant to ensure smooth transition to a market economy were late in coming. And when they came they took too long to be effective. In most cases, the new regulators found entrenched sector vested interests with self serving practices — often collusive — which have mostly remained so. These interests have continued to frustrate effective transition to a free market economy.

To this date the Competition Authority is still finding its way through the market maze, while no competent structures for consumer protection have so far been put in place.

In addition, many sectors have not been bench-marked for cost efficiency and as such businesses tend to easily pass on “inefficiency costs’ to consumers without anyone raising a finger. In the oil sector it was the supply logistics inefficiencies, while in banking it was the out-of-control bad debts.

There is no doubt that the new team at the Central Bank of Kenya (CBK) has over the past one year or so put maximum efforts to streamline the money systems in Kenya including banking.

Governor Patrick Njoroge has often pleaded with the banks to demonstrate a balanced judgment on the subject of interest rates.

Also, the highest authorities in the country have similarly pleaded with the bankers for due prudence on interest rates. Meanwhile, the bank CEOs have gleefully paraded the media and shareholders to announce profits which in amounts are obviously beyond comparison with other economic sectors.

There has been obvious competition among the banks to declare the highest profits. They failed to acknowledge the negative impacts by these earnings on the economy, as they ignored the hostile public mood. Finally, President Uhuru Kenyatta did not have an option but to sign off the interest rate caps in defence of the economy and the consumer.

Has there been perfect competition in the banking sector? My assessment is that it has been competition without effective checks and balances that should address the shared general interests with the consumers, businesses, and the economy.

The oil prices were liberalised in 1994 but it was not until 2006 when a sector regulatory framework was put in place. The oil supply systems remained inefficient and the cost of supply remained high. With prices deregulated, there was often one or two “market bulls” who routinely urged the pump prices upwards and the others would willingly follow suit. Not always was there justification for such increases.

There was no apparent urgency to improve oil sector efficiency because costs could be easily recovered from the consumer. When supply costs went up, prices were urgently adjusted upwards, but when costs dropped, prices remained high longer, and reductions were minimal. As was the case with the banks, public and government pleas to oil companies for responsible pricing went unheeded and in 2010 the government decreed maximum oil prices.

When maximum pump prices or interest rates are uniform across the sectors, the gross margins are virtually fixed and uniform. Competition then reverts to cost management and efficiency while increasing turnover. The most cost efficient and consumer effective oil marketer or banker with the highest turnover delivers the highest net profits.

When the pump prices were capped, many oil companies rationalised operations to weed out unprofitable regional and local business segments. Manpower numbers were reviewed as businesses were re-structured. A number of multinationals sold off and left the market, while local firms with lower unit costs increased their market shares and profits. Customer service became more important for increasing turnover which is the winning game in a regulated fixed gross margin market.