Capping cost of loans may just be good for business

Opinion and Analysis

Kenya Bankers Association vice chairman John Gachora and chairman Lamin Manjang consult at a Press conference: Time will tell the effect of the caps on the economy. PHOTO | FILE 

By NIGEL SMITH

In Summary

• Additional loans to the SMEs should be a welcome kick-start to economy and ability to deliver Vision 2030.

President Uhuru Kenyatta’s recent signing into law of the Banking Amendment Bill 2015 that caps interest rates on loans and sets the minimum deposit rates has been widely reported.

Yet it appears that even the business community is divided as to whether this is a good or bad law.

There can be no argument that high interest rates have continuously hindered growth of Kenyan businesses.

If you compare the rates offered to corporate borrowers in the UK and Europe, for instance, where interest rates are often below five per cent to the average Kenyan rates that stand in excess of 20 per cent, you can see that Kenyan businesses are largely disadvantaged.

The interest rates reduction should of course lower borrowing costs for business and hence bring down operating costs.

In particular, the SME market can now access bank facilities at lower rates, which could enable this sector to expand.

This would be a substantial boost to the economy as businesses that previously did not borrow from banks can now look forward to doing so, and those that did, are likely to seek higher levels of support from their lenders.

Perhaps more important is the “feel good factor”. Kenyan businesses have, over the years, become accustomed to high interest rates and are primed to gain a large psychological relief besides the expected positive impact on businesses as more enterprises seek higher levels of bank finance at the lower rates.

If additional loans, including to the SMEs, are sanctioned by the banks, this would undoubtedly be a welcome kick-start to the economy and the country’s ability to deliver the Vision 2030 at a time when Kenya’s and global economy are facing uncertainties.

But will the lower rates lead to an increase in the supply of credit? The real risk is that the capping of borrowing rates will reduce bank liquidity, leading to a decrease in the number of new loans, especially to “riskier” clients.

There is a real possibility that the reduced liquidity within the banking sector will lead to banks opting for a “flight to quality”.

In other words, banks may all chase the same borrowing opportunities, which could drive the rates of interest down for the larger stable companies, but those that do not fall within this category could see the banks’ appetite to lend, actually decrease.

There may be a cap on the rate that can be charged, but if banks decide not to lend, then the economy and the SME market in particular, will not receive the kick-start and may instead contract.

For those borrowers who currently have facilities with interest rates above the 14.5 per cent cap, I would strongly urge them to take advantage of the new rates, but also, well before maturity, seek refinancing opportunities. Just because you have a facility now does not mean your bank will lend to you at the reduced rate tomorrow.

Market forces

Having to pay a minimum rate of 7.35 per cent to savers as well as capping rates to borrowers at 14.5 per cent, is likely to affect the liquidity of banking sector that has already seen the collapse of a number of banks.

Many banks are confronted with having to slash rates for existing customers, who are potentially “higher risk”.

If the returns on these clients falls by say five per cent, the risk-reward ratio will be out of sync.

It is worth noting that economic experts have been reluctant to see this statute passed, probably due to the potential negative consequences on businesses and consumers.
This is largely driven by past experience in EAC bloc and particularly Kenya where caps were abolished in 1991.

The best way to achieve lower rates is by allowing market forces to dictate through competition within the banking sector.

The Kenyan banking market is highly competitive with 42 banks.

But the levels of liquidity within these institutions will be detrimentally affected, leading to consolidation within the banking sector as the banks are unable to achieve capital adequacy ratios and comply with the new saving and borrowing limits.

Time will tell

Consolidation may be a good thing since the remaining banks would be more liquid and thus would be able to offer competitive rates to both borrowers and depositors alike.
For those who hold stocks in the banking sector, this has already impacted negatively on their price.

Within 24 hours of the law being announced, we saw the value of shares across the banking sector fall by Sh47 billion. Going forward, things may settle down, especially if consolidation is an output of the new legislation.

Consolidation means mergers and acquisitions and shareholders in the remaining banks are likely to be the winners although those holding shares in banks where the “for sale” sign is erected, may have a bumpy ride.

The cheaper loans and higher deposit rates will indeed be good for many, but whether it is good for the overall economy, only time will tell.

Smith is head of debt advisory East Africa, with KPMG Advisory Services Limited (nigelsmith2@kpmg.co.ke). The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG.