News Column

When Will Banks Interest Rates Start Coming Down?

August 14, 2014

Karen Kandie

The high interest rate regime prevailing in the economy appears not about to abate. Not as yet. Recent measures taken to bring down the rates are yet to produce the expected outcome.

First, the successful issuance of the Eurobond by the government heightened expectations that interest rates would come down soon. And why not? With Sh170 billion ($2 billion) of government finances already secured, the government budget deficit was already substantially plugged.

More importantly, the governments hitherto appetite for local borrowing was basically satiated. As a matter of fact, indications were out that following the Eurobond issuance the government was revising its domestic borrowing program from the Sh190.9 billion in the budget estimates to a much lower figure. Perhaps in the range of Sh100 billion.

If the domestic borrowing were to reduce to Sh100 billion, this is significantly lower than the Sh181.2 billion borrowed in the fiscal year 2013/14. The anticipated decrease of Sh81.2 billion which is almost 45 per cent should manifest itself in substantial decrease in interest rates.

The level of government borrowing in the market is therefore unlikely to be the cause of the persistent high level of interest rates going forward. Instead, it will stimulate interest rate reduction as previously issued securities are redeemed and more funds are available to lend to the economy.

Secondly, the introduction of the Kenya Bank's Reference Rate has improved pricing transparency across all the banks. Customers will now be more informed and in a better position to negotiate for lower interest rates.

Thirdly, the disclosure of the total borrowing costs through the Annual Percentage Rate requirement ensures there are no hidden costs. These measures and the sharing of credit information through the credit reference bureaus should result in lower interest rates. Not just in the long term, but in the short term as well.

For what more can be done? Surprisingly, we are yet to see any meaningful reduction in interest rates. According to Central Bank statistics, lending rates were at 16.36 per cent in June having reduced from 17.03 per cent in January.

On the other hand, deposit and savings rates have stagnated at 6.56 per cent from 6.55 per cent and 1.5 per cent from 1.56 per cent in the same period.

Financial institutions are taking interest margins (spread) - the difference between deposit and savings rates on one hand and lending rates on the other hand - in the upwards of 10 per cent.

To join the league of middle income economies, we need to aim for an interest margin of not more than five per cent in the medium to long term.

Interest rates are both a factor of the economy as well as a factor of the industry. While these measures are mainly addressing the wider economic factors, industry factors will need to be addressed as well.

Recent emphasis has been almost solely on the government action to reduce borrowing from the local market. This having been addressed, we now must shift to address the other barriers to a lower level of interest rates.

As the government is known to resolute "no stone should remain unturned to ensure interest rates are lowered to affordable levels". Lower interest rates are crucial to spur investment and economic development. And yet, in the course of targeting lower lending rates, we must not lose sight of the savings and deposit rates.

What we need are meaningful savings and deposit rates that will encourage savings as well as affordable lending rates. And this is where the crux of the matter is, for the tendency is to lower deposit and savings rates in response to lower lending rates in order to secure the interest margins.

The result of which are that savings levels are suppressed, and eventually the same are revised upwards to stimulate adequate savings. This in turn pushes lending rates upwards and the cycle of high interest rates repeats itself.

Consequently, to achieve these two targets, the banking industry will need to yield to lower interest margins and instead seek to widen the customer base.

For in the current regime of high interest rates and low deposit and savings rates, the banking industry may be the only industry that stands to gain. And while it's true that financial institutions are in business and not necessarily sufficiently philanthropic as to lower interest margins at their expense, there is scope to widen the customer base and maintain profitability.

At the end of the day, capitalism does not have to be a zero-sum game. To quote the renowned father of economics and author of "The Wealth of Nations", Adam Smith " it is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country,"

Karen Kandie is a financial and risk consultant with First Trident Capital and a PhD Ccndidate in finance at Catholic University of Eastern Africa.

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Source: AllAfrica

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