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Treasury to guarantee SMEs bank loans to reduce their risk profiles

Treasury building in Nairobi. FILE PHOTO | NMG
Treasury building in Nairobi. FILE PHOTO | NMG 

The National Treasury will guarantee commercial bank loans to small and medium size enterprises (SMEs) as part of the effort to reduce their risk profile, keep loan prices low and ease access to credit.

The proposed credit guarantee scheme will provide third-party credit risk mitigation to the banks by absorbing a portion of losses on SME loans in the event of default.

Details of the scheme are being firmed up through consultations with commercial banks and other stakeholders, but the Treasury believes the scheme will unlock credit to the SMEs, which have been most hit by credit rationing that followed the imposition legal caps on cost of loans nearly two years ago.

“The credit guarantee scheme is a policy tool to direct credit to SMEs thus contributing to sustainable economic development and job creation,” Treasury principal secretary Kamau Thugge told the Business Daily in an interview.

“The start time and amounts (of the credit guarantee scheme) are yet to be determined,” he added.

Sri Lanka launched a similar scheme in 2016 that saw the government contribute Rs500 million (about Sh318 million) in initial capital alongside assistance of selected financial institutions.

Under the Sri Lankan scheme, 75 per cent of the principal amount borrowed is guaranteed by the scheme in the event an  SME defaults.

Treasury’s plan comes as it races to devise a reform package that would convince parliamentarians to repeal the popular interest rate capping law, which has seen commercial banks shy away from lending to individuals and small business.

Kenya introduced interest rate controls in September 2016 with the enactment of a law that limits lending rates to not more than four percentage points above the Central Bank Rate in response to the high cost of credit that saw banks lend to private businesses and individuals at more than 20 per cent. 

Central Bank of Kenya (CBK) data shows that private sector credit grew 2.1 per cent in the 12 months to February this year, slightly lower than the 2.4 per cent in December last year.

Commercial banks pumped more money into government securities in the year to December 2017, even as they tightened credit to private enterprises and individual customers, according to industry data. Financial statements for the year ended December 31, 2017 show that the top eight Kenyan banks invested Sh83.9 billion or 15 per cent more in government debt for a total of Sh625.1 billion even as lending to the private sector grew by a paltry 2.1 per cent in the same period, having been the biggest loser in the credit market following the coming into force of a law capping interest rates.

Dr Thugge said the credit guarantee will aim to ease financial constraints that SMEs and start ups face and increase their creditworthiness. “It’s a mechanism where a third party (the guarantor) pledges to repay some or the entire loan amount to the lender in case of borrower default,” said Dr Thugge.

“The guarantor assumes part or all the credit risk, reducing the risk faced by the financial intermediaries thus making it possible for borrowers that might otherwise face challenges in accessing external finance to obtain credit or to improve the terms and conditions under which they borrow.

"Credit guarantee can therefore contribute to expansion of SME Finance.”

The Treasury has promised the International Monetary Fund (IMF) a repeal of the interest rate capping law, in response to a sharp decline in credit growth, leaving consumers under a cloud of uncertainty over the future cost of loans.

Commercial banks have argued that they are unable to properly price customer risk, especially for SMEs that tend to carry a higher default rate.

Borrowers, who paid exorbitant credit costs before the rate cap, will be watching keenly to see how the Treasury navigates the sensitive and emotive issue either with a partial review or repeal.

The Treasury has since revealed that commercial banks could be allowed to put a risk premium on customer loans for self-assessed probability of default in planned amendments to the rate cap law. 

Treasury chief administrative secretary Nelson Gaichuhie said at a recent banking forum in Nairobi that the proposed loan pricing model will include a flat base rate but an additional risk component allowing banks to differentiate rates for different customers based on risk. 

The proposed amendments have however elicited sharp reaction from various groups, including consumer lobbies who insists that banks will abuse the risk component to inflate the cost of loans.

At the height of bank lobbying against the rate caps in 2015, Kenyan lenders proposed the creation of a Sh30 billion pool of funds for lending to SMEs at friendly interest rates.

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