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February 21, 2019

Is government crowding out the SMEs?

A simple approach to strategy for SMEs./FILE
A simple approach to strategy for SMEs./FILE

There is an apparent reduction of loans to SMEs following the capping of interest rates. This is counterproductive because the essence of capping the rates was to reduce the cost of credit, particularly to SMEs. In a market used to lending at more than 25% to SMEs, the capping at the current 14% is quite an adjustment. It is a regime change that requires new rules of engagement.

Of business essence is that banks have to rethink their risk assessments and profit expectations. Either, they reduce their risk pricing to accommodate high risk SMEs or they cut them from lending all together. The impulse reaction, which is within expectations, is a reduction in lending to SMEs as banks rebuild their business models in the new regime. Granted, it will take time to achieve a balance between access to credit and interest rates that will support a growing economy. The goal is to accommodate a sufficient proportion of SMEs in the credit system at affordable rates. Truth is not all SMEs are suited for credit and some would need to seek alternative sources. Credit to SMEs at high unsustainable rates is destructive to them, perhaps with more negative impact than lack of access. The capping of interest rates will be a success if it delivers low interest rates to the majority of the SMEs in the long term. Its ultimate success is when the controls will become redundant.

Two issues are crowding the transition to the lower interest rate economy. First is the uncertainty of whether the capping law will be reversed as pressure mounts on the government to do so. The recent backing of the reversal by the International Monetary Fund increases the uncertainty. It also prolongs the transition, considering IMF did not give any tangible solution to the problem of high interest rates. Banks may choose to hold on major changes to business models as they wait and see whether the government will backtrack. Secondly, the government’s borrowing programme is currently a haven for the banks. The government is borrowing at attractive high rates, making lending to government instead of SMEs a much better option. It does not make a business case to lend to a risky SME at 14% if you can lend to government at the current Treasury bill rate of 8.7% and Treasury bond of over 13%. Lending to government is risk-free and has minimal administrative costs.

It is risk free because technically, a government does not default on its own legal tender. The implication is that the government ought to borrow at the lowest rate in the market. Considering the lowest deposit rate is set at 7%, this is the borrowing rate for banks. A risk alignment would mean the government borrows at lower than the deposit rate, otherwise the market remains unstable.

Kandie is a financial and risk consultant with First Trident

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