Are cheaper loans good for Kenya's economy?

The president’s assent to the Banking Amendment Bill 2015 has drawn mixed reactions. High interest rates have continuously hindered growth of Kenyan businesses.

If you compare the rates offered to corporate borrowers in the UK and Europe where interest rates are often sub 5 per cent, to the average Kenyan rates, which are in excess of 20 per cent, you can see that businesses are largely disadvantaged.

The reduction in interest rates will reduce borrowing costs. In particular the SME market can now access bank facilities at lower rates, which could enable this sector to intensely expand and this would be a substantial boost to the economy as businesses that previously did not borrow from banks will now look to do so, and those that did, are likely to seek higher levels of support from their lenders.

Perhaps more important, is the “feel good factor”. Kenyan businesses have over the years, become accustomed to high interest rates.

There could have a large psychological and positive impact on businesses, with more enterprises seeking higher levels of bank finance at the lower rates.

If additional loans, including to the SME’s, are sanctioned by the banks, this would undoubtedly be a welcome kick-start to the economy and the country’s ability to deliver Vision 2030 at a time when Kenya’s and the global economy are facing uncertainties.

But will the lower rates lead to an increase in the supply of credit? The real risk is that the capping of borrowing rates will reduce bank liquidity leading to a decrease in the number of new loans, especially to “riskier” clients.

There is a real possibility that the reduced liquidity within the banking sector will lead to banks seeking a “flight to quality”.

In other words, banks may all chase the same borrowing opportunities which could drive the rates of interest down for the larger stable companies, but those that do not fall within this category could see the banks’ appetite to lend, actually decrease.

There may be a cap on the rate that can be charged, but if banks decide not to lend, then the economy and the SME market in particular, will not receive the kick-start as mentioned above and may instead contract.

For borrowers who currently have facilities with interest rates above the 14.5 per cent cap, I would strongly urge them to take advantage of the new rates, but also, well before maturity, seek refinancing opportunities. Just because you have a facility now does not mean your bank will lend to you at the reduced rate tomorrow!

Having to pay a minimum rate of 7.35 percent to savers as well as capping rates to borrowers at 14.5 percent, is likely to affect the liquidity of banking sector that has already seen the collapse of a number of banks. Many banks are confronted with having to slash rates for existing customers, some of whom are potentially” higher risk”.

If the returns on these clients fall by say 5 percent, the risk-reward ratio will be out of synch. It is worth noting that economic experts have been reluctant to see this statute passed, probably due to the potential negative consequences on businesses and consumers.

This is largely driven by past experience in EAC community and particularly Kenya where caps were abolished in 1991.

The best way to achieve lower rates is by allowing market forces dictate through competition within the banking sector. The Kenyan banking market is highly competitive with 42 banks.

But the levels of liquidity within these institutions will be detrimentally affected as described above and this could lead to consolidation within the banking sector as the banks are unable to achieve capital adequacy ratios and comply with the new saving and borrowing limits.

Consolidation may be a good thing since the remaining banks would be more liquid and thus would be able to offer competitive rates to both borrowers and depositors alike.

For those who hold stocks in the banking sector, this has already impacted negatively on their price. Within 24 hours of the law being announced, we saw the value of shares across the banking sector fall by Sh47 billion.

Going forward, things may settle down especially if consolidation is an output of the new legislation. Consolidation means mergers and acquisitions and shareholders in the remaining banks are likely to be the winners although those holding shares in banks where the “for sale” sign is erected, may have a bumpy ride.

The cheaper loans and higher deposit rates will indeed be good for many, but whether it is good for the overall economy, only time will tell.