Costly borrowing to spur risky private credit market - IMF

The continued hike of the base lending rate by the Central Bank of Kenya since mid-2022 could be yielding its core mandate to ease inflation which has since retreated to 5.7 in March.

The move, however, could also be pointing towards increased 'opaque private credit characterized by growing risks on the back of limited supervision and regulation.

According to the International Monetary Fund (IMF), the heightened cost of borrowing from regulated banks because of high central banks' policy rates could prompt credit migration from traditional credit sources to private credit which creates many potential risks.

Early this month, CBK left its benchmark lending rate unchanged at 13 per cent, after a series of hikes from the lows of seven per cent in March 2022.

The apex bank noted that as a result, inflationary pressure had further eased with core inflation — non-food, non-fuel inflation declining, further noting that inflation is expected to remain within the target range.

“This will be supported by lower food prices with the expected improved supply,” CBK noted.

Although the banking regulator did not hint at the prospect of either a rate cut or further hike, it said it will closely monitor the impact of the policy measures as well as developments in the global and domestic economy and stands ready to take further action as necessary in line with its mandate.

With the policy rate now at almost double that of early 2022, commercial lenders often reprice their credit offings to match the prevailing market capping.

Further, the regulator recently approved the risk-based credit pricing mechanism which potentially handed banks the window to raise interest margins, adding to the already high cost of borrowing.

The IMF now says in countries such as Kenya with heightened costs of traditional credit, banks are appearing to become less willing to lend, morose to the middle market, or medium‐sized firms, based on higher risks of defaulting.

Data by CBK concurs this showing the growth in commercial bank lending to the private sector stood at 10.3 per cent in February 2024 compared to 13.8 per cent in January 2024, a 25 per cent decline.

“On the contrary, private credit has emerged as a key lender,” IMF says.

The international lender however says the trend is not market-friendly as it has meaningful risk vulnerabilities.

“While immediate risks may seem contained, the sector could experience large, unexpected losses in a downturn.”

It adds that private credit is typically floating rate and caters to relatively small borrowers with high leverage, and hence, such borrowers could face rising financing costs and perform poorly in a downturn.

Liquidity risk could also rise with the growth of retail funds, the lender adds in part.

“Nevertheless, the risk of increasing retail participation in private credit markets raises conduct concerns as retail investors may not fully understand the investment risks or the restrictions on redemptions from an illiquid asset class.”