Cash shortage tilts market in favour of higher-priced loans

The cost of bank loans is set to rise in the coming weeks as a biting shortage of cash forces the lenders into the Central Bank’s arms where they are borrowing at higher interest rates.

The cash shortage has in the past three weeks forced banks to borrow a total of Sh34 billion from the Central Bank of Kenya (CBK) – the highest such borrowing since 2008.

The money has been borrowed through the CBK’s emergency window, which charges higher interest rates than the banks would ordinarily get by lending to each other.

Use of this highly priced money in ordinary lending operations means that commercial banks will have to adjust their lending rates up to protect their profit margins ending the era of the relatively cheaper loans that consumers have enjoyed since last year.

“The uncertainty created by the liquidity crunch could translate into higher lending rates within three weeks,” said Robert Ndua, a dealer at Diamond Trust Bank, adding that a spiralling of interest rates could hurt the economy.

Commercial banks’ borrowing from the CBK on the overnight window in April alone amounted to about 65 per cent of the total Sh53 billion that banks borrowed from Central Bank in the whole of last year.

The Central Bank lends money to commercial banks at what is considered a punitive rate currently standing at six per cent, and analysts said a persistent cash crunch could jerk up the rate in less than one month.

At six per cent, any bank that is borrowing from the Central Bank is paying a premium because the inter-bank rate - the cost at which banks lend money to each other- closed trading last week at 5.75 per cent having risen from a low of 1.23 per cent in January.

Dealers said the cash crunch was the result of the CBK’s aggressive mop up of cash from the economy to slow down the rate of inflation and stabilise the shilling.

That has made it hard for commercial banks to meet daily liquidity ratio requirements, forcing most to turn to the CBK for loans to keep their operations afloat.

The Central Bank of Kenya lends to commercial banks as a lender of last resort.

The Sh34 billion that the banks have borrowed from the Central Bank in the past three weeks is the highest since December 2008 when the lenders borrowed Sh35 billion in the wake of panic withdrawals that were linked to post election turmoil at the beginning of the year and the onset of global financial crisis in the third quarter of the year.

In the past couple of weeks, a steady rise in interest rates on treasury securities has also left banks holding onto government bonds that are valued less than they were at the time of purchase, forcing the lenders to borrow cash to service customer requirements instead of selling at a loss.

Commercial banks hold more than half of the total treasury bonds, tapping interest income and capital gains from the government papers.

“We were hoping the central bank would inject some liquidity today (Thursday) but it didn’t,” said Mr Ndua.

CBK’s policy switch from a loose monetary stance has seen it pile cash in the government vaults rather than releasing it into the economy thereby starving the financial system of funds.

The liquidity crunch has also hit government borrowing hard, marked by high under-subscriptions of government bonds in last week’s auctions.

Treasury’s borrowing target of Sh18 billion only realized Sh6.23 billion last week, signalling tough times for a government that has set a Sh125 billion borrowing target to finance a yawning budget deficit.

The yield on a 15-year bond the government was selling rose sharply to 12.38 per cent from 10.92 per cent at its last sale in December, while that of a two-year paper cost 7.43 per cent from 5.28 per cent in February.

Analysts said rising inflation, which hit a 16-month high of 9.2 per cent last month, had put CBK in a tight policy dilemma as it seeks to balance between policies supporting economic growth and those controlling escalation of commodity prices.

Joshua Kagia, the head of treasury at Consolidated Bank, said there was a high chance of banks increasing lending rates to match the rising rates on government paper as well as in the inter-bank market, pulling back economic growth which was in the process of consolidating its 2010 performance of an estimated 5.3 per cent GDP growth.

With the 30-year bond yielding 13.9 per cent- a rate that matches the average commercial bank lending rate of 13.92 per cent currently on offer by commercial banks, Mr Kagia said the tightening liquidity will only make it more difficult for banks to lower lending rates to the private sector.

“There comes a time when you have to loosen the taps otherwise you will strangle the economy. At this time prices of goods become expensive as they are also affected by rising lending rates,” said Ignatius Chicha, head of treasury at Citibank.

The inter-bank rate has risen close to the Central Bank Rate (CBR) rate which was set at 6.0 per cent last month.

The inter-bank rate last hit five per cent in May 2009 – 23 months ago –largely due to the global economic crisis that had cascaded to Kenya indirectly through the real sector.

Valued added tax payments- which are supposed to be remitted to Kenya Revenue Authority by the 20th of every month- have also added to the cash crunch.

“Banks have made tax advances on behalf of their corporate clients and have been cash-strained,” said Mark Deane, the head of treasury at I&M Bank. Mr Kagia said CBK’s focus on money supply to control inflation may be only a partial solution and the government should focus on fiscal policy.

“A drastic cut on taxes on oil market sales would have been a good move. This would even increase consumption volumes and bring in more tax revenues,” he said.

Fiscal policy involves government spending and raising of revenue. Excessive State spending increases inflationary pressures but accumulation of cash in the Central Bank has the tendency to limit overall market liquidity, indicating a need for delicate balancing by the financial sector regulator.

Mr Kagia said many big banks, mostly multinationals, have reached their internally set limits beyond which they cannot lend to local banks in the inter-bank window (which requires no collateral) or horizontal repo (interbank lending, which requires collateral security).

The limits have been set for internal controls to reduce exposure in the local market due to country risk, he said.

Incidentally most of the foreign-owned banks have the largest amounts of liquidity idling in the Central Bank-operated clearing house.

“There has been billions in the clearing house but this money cannot be lent because of the limits,” said Mr Kagia.

There is, however, some likelihood that liquidity will improve next month as the government rushes to spend the cash in has accumulated ahead of end of the fiscal year in June, Mr Kagia said.

Joshua Munene, a trader and operations officer at CFC-Stanbic Financial Services, said some banks facing liquidity problems had postponed settlement of claims waiting for the situation to improve.

Additional reporting by Moses Michira.