In credit crunch, the capital markets are equally to blame

Gatundu South MP Moses Kuria’s proposal to tweak the Banking (Amendment) Act, 2016, by way of creating a risk negotiation corridor with a view to jumpstarting bank credit flow into the economy, speaks to a broader policymaking dilemma.

In a letter to the Speaker of the National Assembly, Mr Kuria has proposed to introduce a negotiation window for SMEs and unsecured individual borrowers, largely based on obligor risk-profiles.

Indeed, since the coming into effect of the interest capping law in September 2016, the economy has been evidently credit-starved, with annual private sector advances plummeting from 20 per cent annual levels in 2015 to just under five per cent in 2018. Worst hit are the median entities, the SMEs, which are largely considered to be the economic power engine.

But amidst all these jostles to jumpstart credit, where are the capital markets? In an aspiring economy such as Kenya’s, capital markets, comprising private and public markets for stock, derivative and debt exchanges, ought to be at the heart of the capital allocation game.

In principle, a well-developed capital market should increase savings and efficiently allocate capital to productive investments, which leads to an increase in the rate of economic growth.

It contributes to the mobilisation of domestic savings by enhancing the set of financial instruments available to savers to diversify their portfolios.

Such a role creates a competitive primary interaction between banks and capital markets. But it’s never entirely the case.

Actually, the two tend to co-evolve and complement each other. Banks, through their market-making roles, are core to capital markets, while a well-functioning market provide critical liquidity and capital point for banks.

Take the case of a median borrower, who is often faced with a dilemma. First is the credibility headache, which arises due to weak information about the borrower’s credit quality.

Second is the financial friction, which refers to the total costs, direct and indirect, associated with the execution of a financial transaction, such as borrowing. Banks, with their robust credit-analysis expertise, are better at smoothening out the credibility dilemma.

On the other hand, capital markets, with their large pool of liquidity, are better at resolving the financial friction. Securitisation then becomes one of the key channels between banking and capital markets.

For instance, a mortgage financier can easily pool together its outstanding mortgage book and sell the underlying cash-flow(s) to third party investors as securities (securitisation).

Conceptually, banks sit at the base of financial markets; which is why in the developed markets, capital markets are much larger.

For instance, in the United States, which has the largest and deepest capital markets in the world, the value of listed tradable securities in its public markets is almost five times total banking sector assets.

In South Africa, it is three times. However, in Kenya, we are talking of an inversion, to the extent that the size of capital market is only three-quarters the size of the banking sector; which, broadly, reflects the failure of the capital markets to evolve into the pillar of capital allocation in the economy, leaving banks to dominate.

So when it comes to the economy being credit-starved, the capital market is not infallible.

I recall that in April 2018, the Deputy President William Ruto issued a challenge to the Nairobi Securities Exchange (NSE) to do more to ensure more companies get listed at the bourse and also urged private players to raise money from stock exchange instead of borrowing from banks.

In a way, it was a rallying call for the capital markets to rise up to the plate, a call that continues to ring.