How government is killing economy and blaming banks

In September 2016, the government capped the lending rate by banks at the Central Bank Rate plus a four per cent mark-up. With the CBR at 10 per cent, the maximum rate at which banks can lend money to the private sector is 14 per cent. If the CBR moves up to 12 per cent, the lending by banks would move up to 16 per cent. While this is the case, banks have tried to make the public believe that the government has capped interest rate at 14 per cent, which clearly is not the case.

The interest rate on savings on the other hand has been capped at seven per cent, which is an anomaly and this is where the problem lies.

The interest rate on savings should be over and above the Treasury Bill (T Bill) Rate because of default risk. If the government if offering the T Bill Rate at 8.25 per cent, it would be expected that the savings rate should be a few basis points over the T Bill Rate, say, at 1.5 per cent. This implies that the savings rate should be at 9.75 per cent as opposed to 7.0 per cent.

INTEREST

The other problem we have is the high interest rates the government is offering on Treasury Bonds (T Bonds), currently ranging between 13 and 15 per cent, which returns are near equal to or above the current interest rate cap at 14 per cent. This is what I would call  a fallacy in pricing by the government.

With these high rates on Treasury Rates, commercial banks naturally would invest their funds in government Treasuries where they are getting the same rate of return as on loans to the private sector, a return that is guaranteed on a safe and liquid investment with little or no default risk.

Further, savers would also opt to put their savings in Treasuries as opposed to savings accounts in commercial banks, thereby denying the banks the liquidity they need to lend. In this type of scenario, the role of lending officers in banks becomes redundant while that of the Treasury officers becomes more enhanced. 

The solution is not to remove the interest rate cap but rather to rationalise the way the government has capped the interest rate on savings and further to review its return on Treasuries. And this is very simple. The government should suggest that interest rates on savings be capped to a mark-up raging between one and two per cent above Treasury Bills of similar maturities.

TREASURY BOND

Secondly, lending rates by banks, while pegged at a spread of four per cent above the CBR, should also be allowed a mark of at least two to three per cent of Treasury Bond of similar duration to take care of default risk. Put another way, the return on Treasury Bonds should be lower than commercial lending rates by between two and three per cent. This way, we should be able to bring parity in the interest structure. Commercial banks should also be able to lend to the private sector as opposed to investing in Treasuries.

What has been happening since the capping of interest rates is that the government, through its mispricing of Treasuries, has been killing the economy systematically and blaming it on banks.

The government should borrow from outside as opposed to squeezing banks. Outside funds would also be cheaper than domestic ones. It should be noted that there is no money flowing into the economy in sizeable amounts due to the impact of the anti-money laundering law and the Central Bank Directive requiring any funds receipt of payment over $10,000 (about Sh1,000,000) be explained. Explaining should not be an issue but banks have decided to flag clients’ funds even where enough reasons have been given. What is most interesting also is the fact that when some of these expected funds remain in banks in the UK, Germany and elsewhere, they are not flagged. It is only when they are transmitted to Kenya that they get flagged.

ECONOMY

How then would one expect an economy to grow from a monetary economist’s perspective when funds are not transacted via the financial markets like in any other developed or developing countries?

Recall that growth in gross national product (GNP) using this perspective is a function of the monetary base (money supply) and the velocity factor (the rate at which money is transacted). When banks don’t lend, the velocity factor declines and the GNP declines in equal proportions. Likewise, when we get funds inflows from outside, the monetary base rises and GNP rises in equal proportions.

So, in my view, interest rate cap is not the problem, but rather the way the mispricing of financial instruments (lending rates, savings rates and yields on Treasuries) is being applied and/or directed by the monetary authorities.

In view of the foregoing, the government should not succumb to pressure from banks to review the interest rate cap but rather rationalise the entire pricing of financial instruments.

 Mr Munyaka is an independent banking/financial analyst.