Pundits of the Banking (Amendment) Act 2015 have hinged their argument on three major issues. They say interest rates should not have been regulated because exorbitant rates are driven by the cost of lending.
Secondly, the government was wrong in intervening and should have left free economy dynamics ensure market correction.
Thirdly, low credit rating consumers will suffer most as banks will cut them from financial services. These narratives are not necessarily true.
When the Central Bank of Kenya (CBK) introduced the Kenya Banks Reference Rate (KBBR) the presumption was that if a bank was to lend only at the KBBR rate to a riskless borrower it would get returns.
However, due to variations in the risk of lending banks were to mark up the KBRR rate by a constant K, which was left upon them to determine and disclose. But Alas! Instead of banks treating K as a shrine and apply it diligently, they degenerated K to a bordello, an avenue of financial vice and iniquity to their customers. Banks cited a plethora of reasons on why they could not lower the cost of credit.
However, they did not mention that their high interest rates were not necessarily due to risks of lending, but a chase of returns from Treasury bills. Banks ensured that interest rates they charge did not fall below Treasury bill returns.
Such a scenario would trigger arbitrage in the credit markets, with borrowers taking loans to invest in Treasury securities for the purpose of benefiting from the differentials.
Banks were eager to hold on their dominance of trading Treasury securities. To deter arbitrageurs, they would hike interest rates arbitrarily and in this rat race, blameless borrowers were caught up in the mire.
The new law may not necessarily translate to low cost of credit. In the event of volatility in the economy, the Central Bank of Kenya (CBK) will always raise the base reference rate. The advantage, however, is the rate will not oscillate by the whims of banks.
Was the government justified to intervene? We live in an era which demands more utilitarian government, with a mandate of being concerned with affairs of the people, from the cradle to the grave.
Economic theories which fail to reconcile with the role of the government fail. Even the UK has imposed various interest rate caps.
Free markets ideologies
Ben Bernanke, the former Chairman of the US Federal Reserve Bank, was a studious student of free markets ideologies. When he saw banks engaging in risky securitisation and trading of sub-prime mortgages he asked for restraint in intervening.
The market will regulate, he argued. The Federal Reserve’s indifference eventually blew up to a financial crisis of 2008, whose wounds are yet to heal.
A government that does not intervene to moderate certain aspects of its economy is naive. Governments worldwide use a mix of various tools to boost their economies. It is not populism.
It is all about mechanics of governance. It would have been reckless for President Uhuru Kenyatta not to assent to the Amendment Bill.
Are the banks the final frontiers of monetary economy? Commercial banks play a key role of financial intermediation in the economy. They connect depositors and borrowers.
The fear among some citizens is that bank might abandon the poor. In such a sorry eventuality it would be the banks, not customers, that would eventually lose.
In 1933 the world was recovering from the Great Depression in the US. Banks were blamed, and to deal with them the Glass-Steagall Act, which called for separating investment banks from commercial ones, was passed. The Act’s principles still apply in Kenya even though they have been done away with in the US.
The Act became untenable in the US partly due to the rise of shadow banking, being mechanisms of credit creation outside the purview of regulated institutions.
This reduced, significantly, earnings of commercial banks. Shadow banking is yet to gain root in Kenya but in a globalised economy it is never far off. If our banks make good their threat and cut off the poor, it may turn out to be a blessing.
It will be a chance for the poor to discover other sources of finance. They may discover that one can start a business not by borrowed finance but by equity crowd-funding.
Kickstarter, a crowdfunding platform, is already spreading its tentacles worldwide. They will discover that instead of running to the bank for loans a circle of peers can be a better shoulder to lean on, paving the way for peer-to-peer lending mechanisms, among other sources.
If banks refuse to finance the poor other options will emerge and the lenders will be the ultimate losers.
The author is an Advocate of the High Court of Kenya. Email [email protected]