Opinion & Analysis

Silver lining in rates cap as long-term effects emerge

Guests follow proceedings during a small and medium enterprise (SME) summit aimed at discussing the effects of the bank interest rate cap and emerging opportunities at Villa Rosa Kempinski in Nairobi last November. FILE PHOTO | SALATON NJAU | NMG
Guests follow proceedings during a small and medium enterprise (SME) summit aimed at discussing the effects of the bank interest rate cap and emerging opportunities at Villa Rosa Kempinski in Nairobi last November. FILE PHOTO | SALATON NJAU | NMG 

The interest rate cap has led to several consequences, some of which have been elucidated before in this column.

The most concerning are the effects it has had on monetary policy and access to credit for the private sector. Now, new medium to long-term effects are becoming apparent.

The first is that, private sector, particularly small and medium sized enterprises (SMEs) are getting used to functioning without the credit lines on which they used to depend.

Data from the Central Bank of Kenya (CBK) indicates that credit to the private sector expanded at 3.3 per cent in the year to March 2017, the slowest rate in more than a decade.

So while some in the private sector may be turning to the shadow lending system for credit, many more may be growing accustomed to getting by with no credit lines at all.

In effect, the cap may be dampening the private sector’s appetite for credit. Thus the concern is not only that the economic engine of the country is being starved of liquidity, the engine may be getting used to ticking away at sub-optimal levels due to poor access to credit with dire consequences to the Gross Domestic Product (GDP) growth.

The GDP grew at just 4.7 per cent in the first quarter of the year, and although part of this is due to a contraction in agriculture, the cap has also informed the sub-par growth.

The lingering question therefore is whether dampened appetite for credit will become a long-term trend or whether the private sector will aggressively take up credit lines if the cap is reversed.

Secondly, since the cap has made government the preferred client for many banks, it has created the very situation the government has been stating it has been trying to avoid and that is crowding out the private sector.

Thus the irony is that in government assenting to the cap law, it has created the very situation it sought to circumvent.

Indeed in the 2017/18 financial year the government plans to finance 60.7 per cent of the fiscal deficit using domestic sources.

In the past the government would somewhat limit heavy borrowing from domestic markets, but in the age of the interest rate cap, it is well aware of its priority status and thus seems to be leveraging this to finance the budget with domestic sources perhaps more aggressively than had previously been the case.

Will this become a long-term habit that proves difficult to break?

More efficient

Third, however, there is a silver lining in the cloud; banks are going to come out of this period more efficient than ever.

The cap has caused banks to ask themselves hard questions such as: how much labour is actually required to effectively meet client needs? How many branches need to remain open to serve clients and hit targets?

The cap may be accelerating the automation drive that had already began to occur in the banking sector and banks should embrace this era of capped rates to become more efficient.

Banks will likely emerge from the interest rate cap as leaner and more efficient entities than would have been the case if the cap hadn’t been effected.

This is a long-term effect on the banking sector and may well have lasting benefits on profit margins.

Ms Were is a development economist

anzetsew@gmail.com