Last year, a friend made the startling statement that the Central Bank of Kenya (CBK) was keeping interest rates high to assist government attract credit to itself. To achieve this objective, CBK has created what can only be described as the perfect heist for commercial banks, insurance companies and high-net-worth individuals.Â
Together, they raked in Sh633 billion in interest payments last year. Legal, administratively protected, and backed by the power elite.
I was skeptical at first, believing the official line that high interest rates were for the purpose of controlling inflation. My friend has served at the highest levels in the Central Bank, and in global financial institutions. His claims were not ease to dismiss.
At 2.7 percent, October inflation was the lowest it has been for more than 20 years, not just in the last 24 months that it had been declining.
But CBK maintained the policy rate at 12 percent, then pretended to summon the banks to explain why they were not lowering lending rates. This week, the commercial banks called the CBK’s bluff. Alarmed that growth of credit to private sector was zero in October, they demanded a major rate cut last Monday.
With returns from government securities so high, you would expect the tech-savvy Kenyans to flock in, as they do with land. Yet this does not happen, and for a simple reason.
The CBK has restricted participation administratively. Subtle, but effective. While in theory anyone can participate, and use the DhowCSD electronic platform, the minimum competitive bid amount is Sh2 million for Treasury bonds! The executive previously vetoed Parliament efforts to remove these restrictions.
All this is perfectly legal. Commercial banks are paying saving customers an average of 4.01 percent interest rate on the customer deposits. In turn, banks are earning 13.5-18.6 percent from Treasury bills and bonds, when they lend the deposits to government.
To sweeten the pie even further, interest on infrastructure bonds is tax free. The Treasury is however, now threatening to withdraw this fridge benefit.Â
As a result, lending to private sector, as a proportion for total bank assets has shrunk by 11 percent, from 60 percent to 49 percent in eight years.
In the nine months to September, the total loans and advances to the private sector and households shrank by Sh122.1 billion. A clear indication we are in an economic recession. Yet banks continue to make a tidy profit from this domestic interest arbitrage. A perfect heist.
The commercial banks are shooting themselves in the feet, however, by using the credit bureau mechanism as a tool to enforce collections, rather than to price credit. Threatened with growing non-performing loans, banks are using credit information reporting as leverage to get customer to pay.
In breach of credit reporting rules, leading banks are deliberately refusing to update credit bureau records when they reach new repayment terms with customers.
It is our policy, one smug recovery staffer from a leading commercial bank told me last week. By maintaining a negative listing, they hope to force the customers to repay in full, sooner. All this is happening under the watchful eye of banking sector regulator.
Lending to government is quite easy and straightforward for the commercial banks. All they have to do is bid at the weekly and monthly Treasury bills and bonds auctions.
They can very accurately figure out government’s appetite, and the price their offers accordingly. In any case it is customary for CBK to sound out commercial bank treasurers particularly when they are issuing a large bond. Banks have done very well, holding an average of 52.4 percent of domestic debt in the last decade.Â
There may be hope. Two weeks ago, the Treasury CS appointed four new members of the monetary policy committee—that group of well-fed Kenyans who meet quarterly to consider inflation trends and decide what you should pay in interest rates.
Perhaps they will bring in fresh thinking. But with KNBS reporting a marginal increase in November inflation to 2.8 percent, will the newbies bring change or listen to the mandarins and fall in line?
The banks know that though they benefit enormously from this domestic public debt interest arbitrage, the shrinking loan books present a most serious danger.
As government continues to entice them thereby constraining credit to the private sector, there will be no economic growth, and therefore no real prospects of increased tax revenues, forcing government borrow even more—caught as it were, in a vicious cycle. Could the perfect heist be a poisoned chalice?
The writer is an economist and partner at Ecocapp Capital Â
