What Uhuru should do next to bring rates down in the long run

There was no political mileage to be gained from not assenting to the Bill on interest rate caps.

President Uhuru Kenyatta decided to do what was politically popular.

The flip side is that his decision might send the wrong signals:  We should not be surprised if some demagogue pops up tomorrow to demand introduction of caps on the price of unga (flour).

Granted, interest rates, lending rates and spreads in this country are the highest in emerging markets outside a war zone.

Lending spreads had reached a level where they were way out of sync with some the emerging markets we want to benchmark with such as Chile, Malaysia and South Africa.

Banks in this country practise more usury than was practised in the days of the Merchants of Venice.

Clearly, the case for bringing down lending spreads cannot be gainsaid.

Still, whether the caps as proposed in the Bill the President signed on Wednesday will do the trick is truly doubtful.

When the law is pitted against profit motive, the law is bound to lose. A few years ago, consumers welcomed the introduction of regulation of fuel prices by the Energy Regulation Commission.

Yet we all know that despite the introduction of caps, there is no evidence that consumers enjoy low oil prices.

The problem with caps is that they are very difficult to manage.

Whenever the ERC is about to adjust prices, you will observe hoarding and artificial shortages. Price caps in the oil sector amount to price rigging.

NEW FEES

In the current circumstances, banks will simply make sure that they recover lost income by introducing new fees.

This is what used to happen before interest rates controls were abolished in 1991. Expect to see fees upon fees.

Banks will now charge you commitment fees, negotiation fees, disbursement fees, compensating deposit fees–the list will be endless.

In the absence of a financial sector consumer protection law—and considering that we still don’t have an annual percentage rate (APR) calculated on a comparable and consistent basis across banks as prescribed by the Central Bank of Kenya—it means that banks will simply shift earnings to other fees and commissions.

Introducing caps on lending rates is the easy thing to do. What will bring interest rates down on a sustainable basis include the following:

First, President Kenyatta must direct the National Treasury to start bringing down government borrowing to sustainable levels.

The aim should be to cause government borrowing to glide down to the EAC monetary convergence criteria of three per cent of GDP.

And, as long as government’s borrowing appetite remains insatiable, interest rates will not come down in any significant way because the rate at which the government borrows in the marketplace is the risk free rate.

Secondly, the President should instruct the National Treasury to appoint three or four banks to be primary dealers in government securities.

This will allow the National Treasury to take control of the government securities market and put the government in a position where it can apply leverage to influence the direction of rates.

We often forget that the government is the biggest depositor in the commercial banking system with hundreds of billions sitting in idle deposits in banks at any given time.

The other day, we were all shocked when Treasury Cabinet Secretary Henry Rotich admitted in Parliament that the Treasury neither knows the number of accounts nor the amounts of money belonging to the government sitting in commercial banks.

Indeed, some studies have shown that the government has in excess of 10,000 bank accounts.

BREAKING MONOPOLY

It is a bizarre situation because what it shows is that the government puts its money in bank accounts and then ends at borrowing it expensively through Treasury Bills and Bonds.

If interest rates have to go down in a significant way and on a sustainable basis President Kenyatta must direct the National Treasury to pull out all government deposits in the banking system and to bring it all under single administration by an entity such as the proposed Government Investment Corporation (GIC) that was proposed by the  presidential task force on parastatal reforms of 2014.

Indeed, the case for breaking the monopoly which commercial banks have on the Treasury Bill and Bond markets cannot be gainsaid.

Thirdly, President Kenyatta should direct the National Treasury to immediately implement the Treasury-Mobile-Direct system that will allow Wanjiku to purchase Treasury Bills and Bonds and thus create a thriving retail sector for government securities.

A thriving retail market or government paper will kill the stranglehold banks have on the market for government paper, bring competitive pressure to bear and start influencing interest rates downwards.

And, finally, the President should consider introducing a comprehensive consumer protection law specifically catering for the financial sector, complete with an ombudsman to protect citizens from the tyranny of commercial banks.

What should we expect to happen going forward. I see pressures on banking sector stocks.

Credit growth will stagnate temporarily as banks ponder the implications of the new regime.

And, banks will be reluctant to open savings accounts, preferring to encourage you to put you money in ‘interest bearing’ current accounts.

The biggest challenge now falls on the Monetary Policy Committee which sets the Central Bank Rate.

If they don’t do a scientific job at calculating the rate, negative macro- economic consequences will be felt across all prices in the economy