How State can tame rogue banks in rate cap regime

Treasury wants the interest rate caps removed because small firms are being denied credit, and the balance sheets of banks are under increased pressure. There is no much difference between nationalisation of banks and the rate cap regime.

Unfortunately, not much is in the public domain justifying the rate cap removal and what happens after. One would have expected that an in-depth enquiry about the banking sector is done before any Bill is drafted and taken to Parliament.

The Government could have also sponsored a comprehensive review of the banking system in the form of a commission.

The advantage of a commission is that everyone’s voice is heard. This will ensure a more comprehensive solution than just removing the interest rate cap as a standalone solution. A comprehensive review midwived by a banking commission would interrogate the current business structure, nature of the relationship between financial institutions, and the instruments at their disposal.

The commission could be specific on why interest rates are high to the extent that they are beyond the reach of many ordinary Kenyans. The other day, a bank called someone I know and asked him to take a loan of Sh400,000 through a credit card at an interest rate of around 1.5 per cent on condition that he must pay a contract fee of Sh28,600.

Effectively, my friend received Sh371,400 (Sh400,000 - Sh28,600) but pays interest on a starting balance of Sh400,000. I doubt whether banks ask loan applicants to provide the fee.

This commission couldn’t come sooner. The purpose of banks in which the State has substantial shares need to be interrogated more so when such banks are in the news for bad reasons.

Logically, the finding of such a commission should be relied on to improve the banking law and manage the interest rate debate.

That distinction between commercial banks, cooperative banks and investment banks need to be redefined for better risk management. In a pure risk perspective, a cooperative bank must belong to its members and then define their risk exposure.

Banking commission

This might not be the case for Cooperative Bank of Kenya which is listed on the Nairobi Securities Exchange.

The bank is meant to provide members with banking services at no profit-loss basis. We might have to consider fencing small-time depositors from potential bank panics.

The State should empower a banking commission whose output will be an efficient instrument of economic policy that supports growth, beyond merely rescinding the interest rate cap.

The commission must suggest the changes required to make banks useful in mobilising credit. It can make recommendations on the number of banks needed, including the county banks being suggested by governors. It can also tell us what the bank managers are doing in managing the interest rate.

The commission can provide a broad policy on controlling what bank managers do with deposits and shareholder funds.

It is not good enough arguing that the market will discipline rogue bank managers because markets fail at times. Intuitively, we might not get an optimal solution of what the cost of credit in the country values unless we deepen our understanding of the banking sector.

There might be a need to reconstruct a number of banks’ board of directors. We need boards that are diverse and are made up of professionals from as many sectors as possible.

At no time should the bank chairpersons be non-banking professionals. They should if possible, be hired on a full-time basis.

Another topical issue is the pay to directors and CEOs.

This can be understood better by comparing what they get to the amount of wealth that they create for shareholders. There are banks that don’t pay dividends and experience a decline in share price but handsomely reward their CEOs and other executives.

The role and independence of the Central Bank also need to be reviewed. Since the financial crisis in the US in 2008, the effectiveness of traditional monetary policies has been in doubt.

It is noteworthy that some banks faced challenges even under the regulator’s supervision. It needs to be more assertive on policy, particularly in balancing the benefits of affordable credit.

CBK must also advise the government to uplift the country from slow economic growth and youth unemployment.

It must also question the effectiveness of reserve requirements, open market operations, and use of discount as tools for implementing monetary policy.

- The writer teaches at the University of Nairobi