Banks’ move to tame loan default laudable

Financial Standard

With Odhiambo Ocholla

In a move in the right direction Kenya Bankers Association (KBA), the umbrella body of commercial banks, last week availed raft of measures to forestall mass loan default against the backdrop of high interest rates environment.

The impact of the Central Bank monetary policy action has started being felt across the banking sector though this is price we have to pay to tame inflation and strengthen our shilling. Our economy is currently experiencing high interest reminisces of early 1990s where the maximum lending rate peaked 38.6 per cent.

The cost of borrowing in the country is one of the highest globally. The average cost of borrowing in India is estimated to be 10 per cent while in the major emerging markets, only Indonesia has a higher cost of borrowing at 14 per cent.

Inflationary pressures

In contrast, the corresponding figure for China is six per cent and that for the developed nations, such as the UK, is five per cent.

Indeed with the current high inflationary pressures this move by commercial banks is commendable as customers have less disposal income to spare for any additional interest rates on loan repayment. High interest rate has been occasioned by tight monetary policy stance taken by CBK to cool an overheated economy and politically dangerous inflation.

It’s important that commercials banks are responding positively to rates hike by trying to cushion the borrowers from the impact of the interest rates increase by giving them a softer landing like capping increments in monthly loan repayments at 20 percentage points above the applicable rates and extending the repayment period required to service the loans.

Commercial banks have also accepted to waive penalties for early repayment of loans; an offer that I believe would encourage borrowers to liquidate their loan position to avoid paying high interest rates.

This is good news for the borrowers who are already burdened by spiraling cost of living as inflation top to uncomfortable 19.72 per cent.

I foresee inflation rates subsidising by second half of next year as the tight monetary policy starts taking effects in the economy.

The impact of high inflation rates on individuals is pretty clear. A shilling today is not worth a shilling in one year’s time. The consumer purchasing power is eroded with high inflation rates.

So when inflation is high people loss confidence in money as the real value of savings. Also inflation has great impact on the salaried employees who live on a fixed salary whose income does not increase in tandem with inflation rates.

Inflation tends to hurt employees with poor bargaining positions in the labour market who see the real value of their pay fall.

That’s why we are currently having a lot of labour unrest and strikes in agitation for higher pay. Surprising high inflation favours borrowers at the expense of the savers as inflation erodes the real value of existing debts as the rate of interest on loans may not cover the rate of inflation. When the real rate of interest is negative, savers lose out at the expense of borrowers.

Investors also need to pay attention to inflation because if inflation pressures remain high CBK is forced to raise interest rates.

Interest rates

It’s important to note that commercial banks are also reeling from the effect of revised cash reserve ratio (CRR) to 5.25 per cent which came into effect last week and is expected mob up in excess of Sh7 billion from the circulation.

Cash reserve ratio is the amount of cash that commercial banks must mandatorily hold in reserve. These reserves are designed to satisfy withdrawal demands and would normally be in the form of currency stored with the Central Bank.

As Central Bank raise the compulsory reserve ratios commercial banks will be thirsty for capital, and they will have to accept to pay higher deposit interest rates to mobilise deposits.

As for the customers the decision to raise compulsory reserve ratio would be a golden opportunity for them to make money. Monetary policy stance remained accommodative I expect CBK to lean more on shilling appreciation to temper inflation pressures.

The writer is an investment banker.

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