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Banks' bonds binge casts long shadow on State cheap credit pledge

The government borrows from the domestic debt market mainly through the weekly Treasury-bill and Treasury bond auctions. [iStockphoto]

Commercial banks continue to pile up record amounts of debt in risk-free bonds at the expense of lending to the private sector.

This works against the new Kenya Kwanza government's bid to free up credit to the private sector and individual borrowers.

It comes at a time when the banking regulator has tightened monetary policy to rein in runaway inflation, dishing out more pain to borrowers and signalling an end to the era of cheap credit, which lasted through the Covid-19 crisis.

National Treasury Cabinet Secretary Prof Njuguna Ndung’u said recently the State would endeavour to replace expensive domestic loans with concessional loans from multilateral institutions such as the World Bank.

But this will be a delicate balancing act as it is still expected to rely heavily on locally sourced debt more than foreign borrowing.

This is as the financial system remains awash in cash even as the government seeks to temper foreign exchange risks.

The government’s excessive borrowing from the domestic market through Treasury bills and bonds poses the danger of crowding out the private sector from credit and slowing down economic activities.

Risk-free status and ease of deployment have retained the allure of government securities for lenders, earning them hassle-free returns.

By putting their customers’ deposits into securities like Treasury bonds, banks make the money needed to pay interest on those deposits and pocket a profit.  

When the economy is growing, banks usually have no problem finding borrowers as consumers make big purchases and businesses expand. 

These loans provide better returns than Treasury bonds, which are usually reserved for times of uncertainty because banks will accept their lower rate of return in place of risky loans.

But the majority of banks are still directing their excess liquidity towards government lending, wary of risks of default by the private sector at a time the economy remains fragile.

Top banks’ earnings from the income of lending to the State hit Sh127 billion in the third quarter of this year, according to data analysed by Financial Standard.

CBK Governor Patrick Njoroge. [File, Standard]

Equity Group was the top earner, raking in Sh29.57 billion in the period compared to the Sh20.66 billion it earned in a similar period a year earlier.

KCB Group, on the other hand, earned Sh24.26 billion from lending to the State, up from the Sh18.93 it earned in the same period last year, while NCBA Group raked in Sh18.24 billion compared to Sh14.74 billion a year earlier.

Co-operative Bank earned Sh15.5 billion, up from Sh13.8 billion during the period under review.

This is as Diamond Trust Bank (DTB) earned Sh13.6 billion, while I&M Group made Sh7.87 billion.

StanChart, Absa Bank Kenya and Stanbic Bank earned Sh7.6 billion, Sh6.98 billion, and Sh3.5 billion respectively.

Family Bank, on the other hand, earned Sh2.25 billion during the quarter under review.

"Banks play a huge role in the financial ecosystem through their lending of deposits, ideally aggregating the quantity and smoothing out the liquidity and price curves," said Deepak Dave of Nairobi's Riverside Capital.

"To properly do this, they need to convert about 70 per cent or so of deposits to loans. When banks are showing loan-deposit ratios of 35 per cent-40 per cent, even as deposits increase, it is a clear sign some banks have decided to become bond funds rather than banks."

The latest data from the Central Bank of Kenya (CBK) reveals massive oversubscription in the money markets, with commercial banks offering to lend to the government at a lower rate compared with previous auctions.

The government borrows from the domestic debt market mainly through the weekly Treasury-bill and Treasury bond auctions.

Experts have warned heavy borrowing by the government will elbow out some private firms looking to raise funds at a time a major economic slowdown is looming.

Faced with the huge burden of repayment of domestic loans, the State recently moved to switch short-term government securities amounting to Sh87.7 billion into an infrastructure bond of six years.

National Treasury Cabinet Secretary Prof Njuguna Ndung’u. [File, Standard]

The Kenya Bankers Association (KBA) said recently in its state of the banking industry report for last year that the high appetite for government bonds threatens the fragile recovery of private sector credit growth, especially if the government is unable to institute fiscal consolidation and continues to borrow higher amounts locally.

The banking industry lobby noted that as a share of total capital, banks’ investment in government securities rose to 204 per cent in 2021 compared to 181.7 per cent in 2020 and 148 per cent in 2019.

"It is a clear indication that the bulk of bank liquidity is simply flowing to the insatiable appetite for money from the government and is a particularly odd outcome given this particular presidency is built on flowing money to businesses," said Riverside Capital's Mr Dave. 

"Step one should be to simply unlock the money the government itself is sitting on by channelling money back to banks to fund businesses."

This comes at a time when loans are set to cost more after CBK last month increased its benchmark lending rate by 50 basis points to 8.75 per cent - the highest in over three years.

The hike spelt more pain for borrowers, signalling an end to the era of cheap credit brought about by the Covid-19 crisis.

It is the second time in a row that the Monetary Policy Committee, CBK's top decision-making organ, increased the Central Bank Rate (CBR) in a bid to tame runaway inflation and the weakening of the shilling.

It is the highest that the benchmark lending rate has been since September 23, 2019 when it stood at nine per cent, and comes at a time when the country is grappling with a spike in prices of goods and services.

It dealt a blow to President William Ruto's move to actualise his promise of cheap credit to his support base, which includes jua kali artisans, boda boda operators and mama mbogas, popularly known as the hustlers.

President Ruto last month unveiled the much-awaited Sh50 billion Hustlers Fund, offering hope for affordable and quick credit to low-income earners without collateral.

The fund is a core campaign promise by the Kenya Kwanza administration that was elected on a platform of lifting low-income earners (hustlers) out of poverty.

President Ruto is keen on implementing the campaign pledge that will see individuals and small businesses charged single-digit interest rates to access the money.