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Treasury did no harm by lending to commercial banks
Jua Kali artisans: MPs accused the government of lending out Sh3.8 billion to three banks to lend at high interest rates, yet the money was meant for soft loans to small-scale traders. Photo/JOAN PERERUAN
A gnat settled on a bull’s horn. After a while the gnat asked the bull, “Do you mind if I go now?” The bull replied, unconcerned, “It’s all the same to me: I didn’t notice you when you came, and I won’t notice when you’ve gone.”
A couple of weeks ago, the media reported that an Assistant Minister and a current Member of Parliament sensationally accused the Treasury of lending out Sh3.8 billion in taxpayer money to three banks to lend at high interest rates, yet the money was meant for soft loans to small traders.
The same media report cited the Assistant Minister complaining “With every avenue of persuasion having been shut by some people in government, who appear to want this strange scheme to continue, we have decided to bring it to the court of public opinion.”
It sounds like the government is taking the bull’s stand in the opening fable and is ignoring the gnats that are making a nuisance out of a noble initiative to provide funding to small business owners.
The government is in the business of providing services to its citizenry.
Where possible, it has the power to outsource that service to a provider who is more knowledgeable, efficient and has the necessary capacity to exponentially grow that service.
Giving loans to small business owners is something that Equity, Co-operative and K-Rep Banks have far better experience at doing than the government. Why? The banks are in the primary business of analysing and mitigating credit risk.
Credit risk is the risk borne by a lender that the borrower will repay the loan.
Banks therefore charge a premium for taking that risk over and above the price for the cost of the funds that they are using to lend to the borrower.
So if, for instance, the bank is borrowing those funds from a depositor at three per cent, it will add say 10 per cent as the cost of credit, which is the premium it has assessed for lending to the borrower.
This risk premium takes into account the risk that the borrower will default, the cost of collecting that debt including liquidation of the security (if any has been taken) or the cost of total loss of the loan principle where the loan has been given unsecured.
With that background, the following are the three reasons the bull has decided to ignore the gnat.
Firstly, the government gave each of the banks only Sh250 million or Sh750 million and not the alleged Sh3.8 billion.
Due to the fact that the banks are sitting on their own depositor’s funds which they use to lend, the banks are going to pay Sh5 to every one shilling that the government has lent them to create a fund of Sh1.25 billion per bank or collectively Sh3.75 billion of funds that were made available to small business owners.
In essence, the banks are going to exponentially add to the funds availed by the government to provide a credit line.
Secondly, the alarmist beating of drums about the interest rate differential between what the government is lending to the banks, at six per cent and what the banks are lending to the customers, at 16-18 per cent is nothing but a storm in a teacup.
For the banks, the cost of funds for those loans will be six per cent for the first shilling, and then whatever their cost of funds are for the subsequent Sh5 that they lend.
The difference between what they charge to the borrower and their cost of funds is their credit risk premium as well as their operational costs.
While it is not clear as to who is taking the credit risk on the government funds, the banks are well within their rights to charge the full credit risk premium on their Sh5 as they bear the risk that the borrowers may default on their loans.
Moreover, with regards to the claim that the government lending at six per cent while borrowing from the same market at higher rates is a faulty premise, this initiative by the government is driven largely by social and not business considerations.
The government is not in it to make money, it is in it to provide financing to a section of its citizenry who will raise their own standards of living.
Thirdly, contrary to the alarmists, it is not true that since banks are the only participants in the Government Treasury Bill and bond markets, lending money to banks is a way of borrowing the same money back again.
Risk-free
Institutional investors such as pension funds and insurance companies as well as banks on their own account and on behalf of their depositors participate in the public debt markets.
Furthermore, when banks are purchasing government debt on their own account, it is primarily to fulfil the 20 per cent liquidity requirements placed by the regulator (government debt is deemed to be liquid i.e. can be easily converted into cash) as well as to spread the asset concentration risk by lending to a virtually risk free borrower.
Due to the perceived risk free nature of lending to the government, the returns are of course lower (Treasury bills are currently trading at below five per cent) and thus a prudent commercial bank that is confident in its credit risk management will put the barest minimum in this asset class due to its low returns.
The three commercial banks that have been lent the funds therefore would rather lend commercially at double digit rates than place any funds on low yielding government paper especially if they have already met the liquidity requirements of 20 per cent which is the statutory minimum.
“This scheme is repugnant, shameful and immoral and what we have here is just a tip of the iceberg,” were the parting shots of one of the gentlemen. What is repugnant, shameful and immoral is sensationalising a noble government initiative to use another more skilled provider to give the ordinary mwananchi access to credit.
