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Why interest rate cap was bound to fail

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Central Bank of Kenya Governor Patrick Njoroge speaks during a press conference at Villa Rosa Kempinski Hotel in Nairobi on September 13, 2017. PHOTO | SALATON NJAU | NMG

The interest rate control regime has not worked because we were trying to treat a chronic malady by applying a palliative.

It does not-therefore- surprise me that the Governor of the Central Bank of Kenya (CBK), Dr Patrick Njoroge, says that he intends to push for the repeal of the rate-capping law.

Speaking on Wednesday, Dr Njoroge revealed that a government study had demonstrated that the rate caps had impacted badly on economic growth. I can’t wait to read the contents of this new study.

I hope that its terms of reference were not restricted merely to providing justification to the Treasury and the Central Bank of Kenya to start campaigning for abolition of interest rate caps.

We must not forget this whole idea of introducing rate caps came about because we were trying to tackle a primary problem -namely- high interest rates spreads in the country.

We must expect a comprehensive diagnosis of the problem of high interest rate spreads, including prescriptions for curing the malady from this study. If it falls short of giving us alternatives to rate caps, we will dismiss it as worthless and politically motivated.

We must address the government’s large appetite for cash and how to we can bring down both the level and quantum of government borrowing. The size of the budget deficit must be brought down to the levels comparable with well-run emerging market economies of our size.

Before the caps are dropped, let the governor give us a clear road map on what he is going to do to address the structural weaknesses and inefficiencies in our banking system that are the main contributory factors to the problem of high interest rate spreads.

What happened to the idea of introducing horizontal repos? We don’t have a well-functioning inter-bank market capable of spreading liquidity evenly, both vertically and horizontally.

Our inter-bank market is dysfunctional because big banks do not make credit lines to small banks.  Currently, smaller banks are permanently at the Central Bank’s rediscount window to access expensive liquidity.

Yet when you go to the window frequently, your peers start treating you like a pariah.

What happened to the idea of introducing primary dealers on government paper? The market for government paper badly needs reform.

Experience has shown that when you have primary dealers, the government gets the best lever for transmitting policy direction on interest rates. Even Uganda has a system of primary dealers.

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.

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.

READ: Central bank sets stage for repeal of interest rate caps

I also don’t know what became of the proposal to take away the management of issuance and redemption of government debts from the CBK.

The list of reforms needed to introduce efficiency in the banking sector is long indeed. 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.

The priority of priorities is consolidation. We need fewer, larger and better-capitalised banks able to compete more effectively with each other in a manner that drives down interest rates.

Do interest rate caps have relevance in our context? Maybe. But only if the purpose is consumer protection. Even in the US, there are state by state usury laws that include caps on consumer loans.

In South Africa, small borrowers are protected by interest rate caps regulated by a consumer protection body- the National Credit Agency.

In our case, the caps regime was not introduced with the objective of protecting the ordinary borrower from loan sharks, It serves the interest of the rich.