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Small banks struggle with liquidity as rate cap law enters fourth year

The rate cap law, which came into effect in August 2016, placed a ceiling on loans at four per cent

In Summary

• Private sector credit growth has been sluggish since the government capped commercial lending rates as banks turn to state bills and bonds to boost performance.

• For private sector credit growth to have a significant contribution to the country’s economy, it needs to be more than 15 per cent.

KBA CEO Habil Olaka and Research and Policy Director Mr. Jared Osoro
KBA CEO Habil Olaka and Research and Policy Director Mr. Jared Osoro
Image: FILE

Despite a significant increase in loans and deposits by smaller banks, the lenders have been struggling to stay afloat as the rate cap law hits its third year.

A report by the Kenya Bankers Association shows mid and low level banks have had to trade off profitability for liquidity in a policy-tight market.

This has in turn negatively impacted borrowing especially for households and small businesses as the banks seek to prop up their balance sheets amidst returns-risks trade-offs and cost management and efficiency enhancement.

“The lower rate of loans and advances growth compared to deposits has seen their relatively lower loan-to-deposit ratio, thus manifesting their conservative stance,” KBA director of research and policy Jared Osoro said.

The rate cap law, which came into effect in August 2016, placed a ceiling on loans at four per cent above the Central Bank rate while a floor of 70 per cent of the CBR was placed on deposits.

This was however reviewed last year, removing the floor on deposits to allow banks more wiggle room to widen their interest margins.

Private sector credit growth has been sluggish since the government capped commercial lending rates as banks turn to state bills and bonds to boost performance.

CBK data shows private sector credit growth fell from its peak of about 25 per cent in mid-2014 to 1.9 per cent in January 2018 — its lowest level reported last year.

According to CBK, for private sector credit growth to have a positive impact on the country’s economy, it needs to be more than 15 per cent.

In 2018, Finance and insurance, consumer durables and business services were the best performers in terms of credit access.

On the other hand, credit to the government has averaged about 15 per cent compared to 2.4 per cent to the private sector reported last December. This means lenders have resorted to risk-free Treasury Bills and government bonds at the expense of lending to the private sector.

Last October had the highest recorded rate of private sector lending since introduction of the rate cap law at 4.4 per cent.

Speaking during the launch Stanbic Bank regional economist Jibran Qureishi said the CBK charter alongside with a reform of the law capping interest rate would significantly turn the tide for both banks and borrowers.

“We firmly believe that a risk-based pricing framework is one of the ways that will support the resolving credit constraints that the capped credit pricing has imposed,” Osoro added.