Why President shouldn't sign Bill on interest rates into law
President Uhuru Kenyatta signs a Bill into law at State House in Nairobi. PHOTO | PSCU
What you need to know:
Banks are reluctant to access liquidity from the Central Bank of Kenya's borrowing window for fear of being treated as pariahs by their peers.
There is a strong case indeed for bringing down operating costs by sharing infrastructure such as ATMs, branches, switches and core banking infrastructure.
- The banking sector is ripe for structural reform.
- The priority is consolidation.
On the proposal to return to the ancient regime of arbitrary caps on interest rates, we need to take off our blinkers, stop worrying about symptoms and start addressing the core causes of high interest rates spreads in this economy.
My advice to President Uhuru Kenyatta on whose shoulders now sits the decision on whether or not to introduce interest rate caps as proposed in a Bill recently passed by National Assembly is this: if you assent to the Bill, your effort will be tantamount to trying to build a house from the roof.
Granted, we have some of the highest lending spreads when compared to emerging market economies of our size and level of development.
Our banks pay depositors very little in interest only to lend the same money they have collected from depositors to borrowers at rates higher than rates charged by the merchants of Venice. If he wants to get to the bottom of the problem, the question President Kenyatta must ask himself before taking a penultimate decision on this matter is this: why are interest rates high in this economy?
He will discover that the biggest contributory factor to this problem is government borrowing. Thus, it follows that the first thing the president must address is how to bring down both the level and quantum of government borrowing.
The truth of the matter is that interest rate caps as proposed by Parliament will not work if the government does not address its own large appetite for cash.
The size of the budget deficit must be brought down to the levels comparable with well-run emerging market economies our size. Second, the president needs to move to get the government to regain control over management of market for government securities.
The reason the government sometimes borrowed expensively from the market is because commercial banks have over the years more or less captured this market for government securities, allowing them to dictate terms.
Such is the monopoly and stranglehold which banks have over the market for government paper that five CEOs of the top commercial banks can today decide on the golf course to quietly orchestrate a boycott of a specific T-Bill auctions if they don’t like the level of interest rates. Indeed, the management of the government securities market is ripe for major reforms.
LEVERAGE PLACE
We need to gradually transit to a system where the government is allowed to leverage its place as the single biggest source of money and seller of liquid securities in the economy, so that it can start to exercise soft influence more aggressively on the direction of interest rates in the economy. I don’t know when and where we dropped the idea of introducing primary market dealers to help the government in improving management of primary issues of securities.
Indeed, the idea of introducing primary market dealers was among the key proposals of the blue ribbon presidential task force on parastatal reforms, whose recommendations the president accepted in June, 2014.
There is also a crying need to professionalise the management of issuance and redemption of government debts. When you look at trends in the rest of the world, countries are now establishing independent and dedicated treasury management agencies mandated to minimise the long-term cost of government debt. Where this type of institution has been established, you will see that management is under trained fund managers and investments professionals.
If we were to set up such an entity, we will resolved the current conflict of interest where the Central Bank, under its price stability mandate may be signalling an easing of interest whereas – as fiscal agent of the government – it is under pressure to improve uptake of Treasury Bills by offering high interest.
Interest rates caps will not work until there is more competition in the banking system. On the face of it, we have 44 banks fighting with each other in the marketplace.
But the reality is that banks don’t compete with each other effectively. A few banks dominate and the market is highly market. The interbank system that would spread liquidity between the banks is more or less broken.
Banks are reluctant to access liquidity from the Central Bank’s borrowing window for fear of being treated as pariahs by their peers. There is a strong case indeed for bringing down operating costs by sharing infrastructure such as ATMs, branches, switches and core banking infrastructure. Rwanda and South Africa have centralised ATM switches.
Interest rates caps will not bring borrowing costs down. The banking sector is ripe for structural reform. The priority of priorities is consolidation.
We need fewer, larger and better-capitalised banks able to compete more effectively with each other to drive down interest rates.
