The Kenyan banking industry is caught up in a pincer movement. Conditions for lending are tighter than they were, slowing lending growth rates to two per cent currently, from 20 per cent in April 2015. And industry profits are declining.
The result, for many businesses that rely on bank credit, has been the absence of critical finance during an extended hold on new business and slowed payments throughout the country’s prolonged election period.
The Supreme Court nullified the outcome of the August 8 presidential elections, and ordered that the exercise be repeated (it was held again on October 26).
For others, the tightening of lending has limited working capital to enable utilisation of existing capacity and forestalled expansion of capacity.
All this will undoubtedly play out into the economy’s overall growth. As is becoming evident from the near-consensual downward review of the economy’s growth performance, at least in the near term, the tight credit conditions look unlikely to ease in the months ahead.
Meanwhile, lending has become riskier. Nine out of every 10 borrowers are still meeting their repayments; however, many of them are staying in business precisely because of bank credit.
Poor business conditions saw the proportion of non-performing loans (NPLs) touch one tenth of all bank loans by June this year. NPLs now make up 9.91 per cent of the industry’s portfolio, from 9.5 per cent in March, and climbing still.
That compares to a global average of four per cent, according to a 2015 World Bank report.
The non-performing loans in Tanzania stand at about 10.8 per cent of the total loans while in Uganda they are 6.2 per cent.
Any NPLs in the range of 10 per cent to 20 per cent are a material risk to economic performance.
When economic uncertainty surges and NPLs squeeze into returns, banks stay operational by adjusting their business models to mitigate risk and preserve shareholder value, ensuring that returns remain above inflation rate.
With inflation running at some five to six per cent, maintaining value in real terms requires that banks operate at a spread that covers their cost of capital as well as inflation, operating expenses and default risk.
Interest rate cap
And that is where the second “squeeze” comes in: The interest rate cap introduced by the Banking (Amendment) Act 2016 that limits free pricing of risk.
It is widely thought — and arguably rightly so — that after the Banking Act took effect, private sector lending became scarce because it has been crowded out by public sector borrowing.
And it is true that in the balance of lending between enterprises and government, the weight of borrowing has moved to the “risk free” public sector.
In fact, research published by the Kenya Bankers Association Centre for Research on Financial Markets and Policy has found that domestic debt — or government borrowing — has had a significant and negative effect on private sector investment and household consumption.
It is clear from the researchers that domestic debt crowds out local actors, such as large corporates and small and medium-sized enterprises, in terms of financial capital allocation.
Crowding out effect
In the interest rates controlled environment that we are under, this crowding out effect is amplified mainly through the “quantity channel” with available domestic credit being redirected away from viable private sector ventures to fund government expenditure.
The degree of redistribution is primarily about risk that cannot be priced for. For lenders the choice is between losing money through negative real returns during the periods when public borrowing is at rates below inflation; and committing to private sector loans that extend for years ahead, but cannot cover their own operational costs and market risk.
This would seem to be a holding position for banks in a struggle to make the numbers add up for their shareholders, who include the custodians of our pensions and other institutional investors.
To the extent that the interest rate controls have made it possible for government to fund its borrowing requirements easily, even affordably, there may be scant political will to liberalise the credit markets any time soon — although the need is pressing from an economic perspective.
When the rates are freed to reflect the country’s rising private sector risk, bridging finance will once again be viable, and businesses will get the new wind to thrive.
Habil Olaka is the chief executive officer of Kenya Bankers Association.