A successful economy needs a financial system that moves funds from savers to borrowers. This means that those who save and lend, and those who borrow must have confidence in the financial system.
An efficient financial system ensures that the shillings you save are used by those with the best productive investment opportunities.
Much as financial systems contribute to economic development by providing people with useful tools for risk reduction, their failure translates into financial crises that can destroy wealth.
Are we facing an infant financial crisis or how stable is our financial system?
The sooner the Treasury, the Central Bank of Kenya and our economists answer this question the better.
The answer lies in in the evaluation of financial markets. I am not sure that we have an adequate financial management system and trying to manage interest rates through Parliament has not helped the financial system.
Much as most banks reported ‘huge’ profits, the balance sheets of some banks are deteriorating; that is, some of these institutions are reporting a decline in operating income.
This means the value of assets held by banks could be on the decline.
A few years back, we had a credit boom and banks were lending based on payslips, but it appears that lending avenue is exhausted.
However, that excessive payslip lending had the effect of pushing asset prices to the sky.
Now that this payslip lending group cannot borrow any more as they have exhausted their debt capacity, we are faced with a decline in asset prices that could lead to a financial crisis.
Economists describe financial crises as major disruptions in financial markets characterised by sharp declines in asset prices, firm failures and lack of credit.
We already have people selling their assets at fire-sale prices, the level of unemployment is high and many firms are closing or scaling down or relocating to other countries.
For a start, we are not exact about our growth rate nor are we open about our population.
There are no regular reports on employment, and we have not reconciled interest rate and inflation by asking questions such as, what does it mean if the interest rate is lower than inflation?
In which case borrowers benefit and lenders suffer; or what does it mean if the interest rate is higher and inflation is lower?
In which case borrowers suffer and lenders benefit.
This inadequacy suggests the difficulty in designing an appropriate financial system. The tax system and the VAT on petroleum products are not helping our economy either.
At the macro level, we need to determine the amount of credit required to support this VAT tariff and establish if our banks have the capacity to provide credit to support this tax.
The basic question is: you were paying Sh1,000 for a product, but now you need to pay Sh1,160, but your income has not increased; where are you going to get this Sh160 from?
If 20 million of us each requires an additional Sh160, then the total credit required would be Sh3.2 billion for a product worth Sh1,000 to keep our standard of living unchanged. And this is just one product.
Does our banking system have the capacity to meet this kind of increase credit for all of us? What happens when our financial system is inadequate or the interest rate is too high?
What might befall us if investors lose confidence in Government securities?
The Government refinances a lot and if investors lose interest in its securities, it would have to look for money elsewhere or default.
Given the level of national debt, that would be a financial disaster. And if we continue borrowing, we might reach there.
-The writer teaches at the University of Nairobi