Why county banks are a bad idea

The decision by some counties to form their own commercial bank needs to be reviewed.

Kenya is overbanked and additional lenders might not help our economy very much.

Competition is healthy, but too much of it in the financial sector can translate into a price war that might harm the industry. The decision by counties appear to be politically-driven rather than economic.

There is a feeling that “other tribes” have their own banks and therefore, “we must have our own banks.”

Unfortunately, there is nothing like a tribal bank.

We have banks owned by individuals from other communities.

If we continue with this line of argument, it could open the floodgate to counties owning petrol stations and other businesses.

The national and county governments should concentrate on supervising what businesses do - contrary to running business.

The argument to start county banks is noble, the main argument being that such a bank would lend to weaker and priority sectors ignored by commercial banks, thereby serving public interest.

It is possible that county-based banks would place politicians in control of the economy. The downside would be that this would undermine democracy.

My argument is that others should own banks while both national and county governments should make laws that ensure that these banks support their economic agenda.

Governors have their work cut in the Constitution and this can be improved by the county assemblies.

I’m in no way saying that counties owning a bank is bad, taking into account our current level of development.

I have always argued that money is always available and that it is the idea to fund that is the problem.

Counties are basically states, and the idea of State banks is scary.

I do not know who the governors affected are talking to, but they need additional information on how the banking sector in the country operates before venturing into the business.

Commercial banks are important because they channel funds from those who do not have a productive use for them to those who do.

In a market economy such as ours, a sector failure would be devastating and this explains why lenders are heavily regulated.

County bosses need to be aware that it is almost impossible having “your bank.”

There are fundamental principles that bank managers invoke to manage the financial institutions successful and these principles are independent of bank ownership.

The Central Bank of Kenya is mandated to oversee banks.

However, the way the market for products and services work is simple but difficult to compromise.

Same product

If there is a product selling in the market for Sh1,000 and you set the price higher than that, no rational person would buy it because in most markets, the law of one price applies.

The law of one price states that identical products cannot sell at different prices.

Banks depend on deposits and from these deposits, they create loans to their customers at a charge (interest).

These deposits are supplied by households that expect to be rewarded in terms of interest.

The household will take their deposits to banks that pay them highest interest.

For example, if the county government pays an interest rate of three per cent on deposit and a privately-owned one is pays six per cent, the latter will be more popular.

The county banks will be starved of deposits.

As a result, they will have no money to loan out. The county governors must be aware of how financial markets operate.

They must also be aware of the “invincible hand.”

What the national and county government needs to do is to stop running businesses but in the case of banks, create conditions that are conducive for economic growth and financial stability.

That environment must guarantee a constant flow of funds for depositors.

It must also guarantee that the funds are put to the best possible use. The national and county governments can legislate what is the best possible use of these funds.

However, if the counties need capital for infrastructure and creating enabling environment, they can issue county bonds.

Going by experiences elsewhere, the idea of State banks might not work well for us.

India tried to solve their banking problems by creating national and State banks even though Indian States are far much bigger than our counties.

As at September 2017, BBC reported that India’s largely Government-owned public sector banks are in a mess.

Seventeen of the 21 banks have a bad loans rate of 10 per cent or more (as at March 31, 2017).

Bad loans are credit whose repayment has been due for 90 days or more.

For example, the Indian Overseas Bank has a bad loans rate of 25 per cent.

The BBC report concluded that these bad loans are largely the result of lending to an industry where the overall bad loans rate stands at 22.3 per cent.

-The writer teaches at the University of Nairobi