Deputy President William Ruto has in the last few weeks raised concern about the high spread between lending rates banks charge borrowers and the deposit rates they offer to savers. In the Vision 2030 blueprint the government is banking on the private sector to push the economy to a 10 per cent growth rate and achieve a middle-income status by 2030. The sector largely hinges on the availability of affordable credit from financial institutions. Mr Ruto believes that not enough affordable credit is being advanced to sectors of the economy because of the high lending rates. He has a point. High bank lending rates, in particular, are a source of worry as they inhibit investment and economic growth. They are stifling the productive sectors of the economy as it makes the cost of doing business too excessive and businesses can't pass the benefits of their business to consumers in the form of lower prices. If we have to have the transformation we envisage, we would need to grow the economy and we cannot do so if these sectors are unable to borrow to expand their businesses. Unemployment The high lending rates are also indirectly worsening the unemployment situation in the country. We therefore need to work towards a situation where people who are credit worthy should be able to borrow money to expand their businesses without being unduly restrained by the high cost of borrowing. That's one way the economy can expand and all can benefit from the transformational agenda of the government. Finding answers to the problem should, therefore, be a policy priority and we hope Mr Ruto's concerns will initiate policy actions to address this issue. He has asked the Treasury and the other stakeholders in the industry to look for ways too address this issue. But are the banks entirely to blame for the high spreads they earn? Not necessarily. The fiscal and monetary authorities of the government Mr Ruto is DP, is in fact a major contributor to this problem. There are two ways the fiscal side of the government is contributing towards the big spread the banks are enjoying. First, the high direct borrowing by the authorities to finance the budget deficit increases the competition for funds and drives up interest rates. The government's huge public sector borrowing is normally insensitive to interest rates. Investment credit is very sensitive to interest rates and businesses, investors and even households would not borrow and/or the banks would not lend unless they believe the expected earnings before interest and tax on an investment opportunity exceeds interest rates. On the other hand the Treasury, the largest borrower, would borrow any amount regardless of interest rates. So long as the government is willing to borrow hugely and the Treasury bill rate is attractive, the banks would have the tendency to channel funds into the risk free bills rather than lending to the real estate sector, unless borrowers are willing to pay high interest rates. Second, high level of payments of arrears to infrastructure contractors and other suppliers of government's goods and services also leads to high borrowing by these entities, which is in reality a ''proxy'' government borrowing. To lead the way, Mr Ruto must start by ensuring that his government puts its act together. The Treasury must keep its direct borrowing within programmed and statutory limits to reduce pressure on interest rates and crowding out of the private sector. Clearance of domestic payment arrears will also reduce the related government ''proxy'' borrowing by its creditors and thereby reduce banks' non-performing loans and costs. As for the monetary authority side, the Central Bank of Kenya normally would use tight monetary policy to ''protect'' the exchange rate by keeping interest rates at levels that would prevent excessive outflow of capital. The monetary authorities also contribute to high bank lending rates through the reserve requirement policy. This policy requires banks to deposit a certain per cent of their deposits at the CBK. CBK should, through moral suasion, encourage a consensus on what constitutes a reasonable margin. It is clear that in the present situation the real economy is at the mercy of banks as fund providers, and the regulator must play the role of consumer protection and ensure that bank charges are reasonable and consistent with both the profit motive of individual banks and in the interest of the system. On the other side of the equation are the banks. We all recognise that banks face high lending risks, including inadequate collateral, inadequate borrower identification and high loan default rates. These factors lead to high non-performing loans (NPLs) on the banks' books and increase their costs. Non-interest costs is however the single largest contributor to the interest rate spread and effectively keeping the lending rates high. Banks should cut costs through innovations such as investment in technology, enterprise resource planning and mobile and agency banking that will help reduce the cost of delivery of banking products and hence bring down the cost of borrowing. Banks must realise that excessive interest charges increase the risk of huge loan losses and financial instability in the medium term which creates a necessity for them to moderate short-term profit expectations and curtail expenditure on their bloated overheads. They must see provision of affordable credit to be something that is in their own interest. The persistence of high interest rates in the economy is the collective responsibility of banks, fiscal authorities and monetary authorities. Each is in one way or another contributing to the problem and each would need to play a big role to find a solution to the problem. Wehliye is senior vice president, Financial Risk Management, Riyad Bank , KSA.
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