OWINO: Why rate cap law was a tragic gamble
5 days ago, 07:01
On September 14, 2016, the Banking (Amendment) Act 2016 came into force, imposing a cap on lending and deposit rates.
One month earlier, lawmakers had passed the amendment, hailing it as a sage move that would see benefits accrue to small and medium enterprises (SMEs) in the form of affordable loans.
The prevailing wisdom was that the government would — at the stroke of a pen — give more cake for consumers.
That credit would dry up for small private borrowers was an outcome that needed no economic mystic-analyst types to proclaim.
In implicit opposition to the cap, CFC Stanbic Bank regional economist Jibran Qureishi, Robert Shaw and many others sang a plain, well-worn chorus — the cap will lead banks away from lending to small borrowers.
More damage was wrought when the government continued to borrow heavily from the very same market it sought to create for the private borrower, depriving the economy of credit and growth.
The government effectively offered cake to the public with one hand and then gobbled it up with the other, leaving stomachs growling.
A year on, President Uhuru Kenyatta — whose signature brought the law into effect — reversed the conviction he shared with the legislature, conceding that the amendment did not have the desired effect.
The adverse effects of caps on small borrowers come as no surprise. It is a globally documented phenomenon.
This reversal must leave the public questioning the insights that drove the decision to implement an interest rate cap, the advisers that proposed it and the depth of considerations made by the executive before signing it into law.
Banks play an important intermediary role in the economy by connecting those who have cash and are in want of investment opportunities to those who are or could be engaged in productive economic activities but do not have the financial wherewithal.
The banks ‘buy’ deposits and ‘sell’ loans, earning the difference. Those deposits and loans are bought and sold at an ‘interest rate’.
Additionally, the buyers of those loans are businesses and the government.
The government is a less risky borrower than the small businesses and also has the capacity to be a bigger player in the loan market than several businesses put together.
If the government and many small businesses competed for loans at the same interest rates, banks will prefer to lend to the government.
Because banks spend a lot of time and money vetting and tracking borrowers, they will prefer to lend to the government even if both the small businesses and the government were paying the same interest rates.
As the cap came into force, the government gave the verbal signal that it would stay away from the domestic credit market and then did the opposite by increasing its domestic borrowing.
The effect was that the interest rate cap made it difficult for the SMEs, in whose name the law was enacted, ...
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