CBK must act on lending rates, not lament

A meeting with bank CEOs a couple of weeks ago clearly has not yielded the desired results. The BD lead story on Monday this week was how banks have ignored the CBK’s rate cut signals, reporting of the governor’s lamentations last Friday.

As the CBK leadership is all too aware, the low inflation window may soon disappear, and with it, any real chance of using low interest rates to stimulate economic growth.

If I were the credit director in a commercial bank, I too would ignore the governor, after all, reducing lending rates needs action, not lamentations. Here is why.

Commercial banks exist to make money for their shareholders. They do so by picking up deposits on the cheap and flogging those deposits to borrowing customers at higher rates than they pay for them. The government is by far the best borrower. 

Read: Why is State keeping rates high?

It borrows every week, with securities that are tradeable, and therefore very liquid. Because government can print money or issue yet more domestic debt to pay the old, the probability of defaulting on domestic debt is very low. Portfolio management costs are extremely low.

No expensive staff to go meet clients or visit projects, and for infrastructure bonds, interest earned is tax free.

At the weekly auction of short-term securities, the standard offer amount is Sh24 billion in Treasury bills. Bonds are auctioned once a month for various higher amounts.

The government has for long demonstrated at every auction that it is hungry for cash, often accepting twice or more of the standard offer amount. It picked up Sh42.2 billion last week, Sh34.6 billion the week before, and Sh46.4 billion three week ago.

Historically, the 91-day Treasury bill has been a key barometer for the goings on, and a standard benchmark for the rest of lending rates.

Even development finance institutions price corporate loans at T-bill plus a risk margin. Loans to small business attract even higher risk margins, and because they are difficult and costly to make, they come last in the list of preferred customers. 

Making loan to a small business can take many months in the back-and-forth exchange of documents and meetings between bank staffers and the small and medium enterprises (SMEs). You can’t be certain of the audited books—if they exist.

Perfecting the collateral takes longer still. Then there is performance risk. The SMEs struggle with market vagaries. They face competition, while the government doesn’t, and the latter’s revenues are mandated by law. Bidding for Treasury bills and bonds needs only one staffer, and you can place Sh50 billion, assuring yourself of profitability for the years that the bond is outstanding.

After a long spate of interest rate hikes, the CBK has reversed direction, now that inflation is low. But the change of direction is taking time, much the CBK’s frustration. The 91-day Treasury bill rate peaked at 16.02 percent in the July 22, 2024 auction. It has since steadily declined to 10.46 percent in last week’s auction. 

If I were a commercial bank treasurer, seeing that the CBK policy rate guidance is 11.25 percent - higher that the T-bill rate at the weekly auction, I would make quick adjustments upwards, to match the guideline! And with the government borrowing strongly, I would not look for those SMEs, appeals to patriotism, notwithstanding. 

If the governor wants the lending rates to come down, he would introduce competition in the securities market. He could use technology to borrow directly from Kenyans, who would probably accept 5-6 percent return, seeing that their deposits are attracting four percent from the banks. 

The Treasury on its part could adjust the borrowing schedule. Instead of coming to the market every week, they could do it every two weeks. They could also borrow less, if they want the liquidity to go to the private sector.

The CBK governor could even introduce more liquidity by bringing down the cash ratio from 4.25 percent to say 2.25 percent, releasing more than Sh100 billion back to the banks.

He could even abolish the ratio altogether, as there is no evidence that it is needed. With such liquidity, banks would be forced to find borrowing customers other than the government.

But since the Treasury and CBK choose not to act but lament and make meek appeals, the banks are correct to ignore.

The writer, an economist, is partner at Ecocapp Capital and former governor of Laikipia County