Rate cap: Who between governor and banks will blink first?

In Summary

• Njoroge has a tough task of ensuring that in post rate capping regime, Wanjiku is protected from ravenous lenders.

He fashioned his entry at Central Bank of Kenya (CBK) as an era of new normal. True to his word, governor Patrick Njoroge controls the stars of all the 40 commercial banks.

Simply, Dr Njoroge takes no prisoners. Once at pains to explain how three banks sunk into receivership in quick succession and his admission that CBK “was sleeping,” he wants everything in the palm of his hands.

If there is one thing you cannot get a Kenyan banker to comment on since governor Patrick Njoroge sat at the apex bank, it is the value of the shilling. Last week, bankers were tongue-tied about yet another thing: How they would price their loans now that the rate cap is gone.

The repealed law was obvious and elaborate, four percentage points above the Central Bank Rate (CBR). This meant that when the Monetary Policy Committee meeting adjusted the CBR, banks would have followed suit.

But when Smart Company polled several top banks on what direction they were likely to take, they all refused to give their position.

Dr Njoroge, who has on many occasions reiterated his enthusiasm about the consumer, now faces the test of shielding customers from exorbitant interest rates while at the same time not appearing to interfere with market pricing.

Gave them marching orders

On Tuesday, CBK sent out a terse letter to all bank chief executives ordering them to change the terms of all existing loans into fixed rates warning them that they can only reduce interest rates on existing loans. CBK then gave them marching orders on how they will have to conduct themselves post-rate cap.

“Banks cannot revise interest rates upwards for credit facilities entered into while the interest rate caps were in force. In the circumstances, unless revised downwards the interest rates of such loans will remain fixed until the loans run their full course,” CBK assistant director of banking supervision Matu Mugo said in the circular.

This solves one big problem for the governor, because a Sh2.766 trillion loan book will remain priced at a maximum of 13 per cent until maturity, muting any significant predatory pricing in the near future.

Instead, the loans will be re-priced as they mature, which will depend on how long each bank had given out loans.

“They are not going back to the same old ways of the past, the wild west kind of banditry,” Dr Njoroge said recently calling on investors to accept reduced returns even in the absence of caps.

An analyst who did not want to be named because they have dealings with the CBK said large banks will be exposed since they have advanced substantial sums to real estate and corporate loans tied to loan holdings.

About 17 per cent of Kenya Commercial Bank has been loaned out to real estate while Equity Bank has given 23 per cent of their book to housing loans. Cooperative Bank has packed 12 per cent of their loan book in real estate.

“What he is doing is not a bad thing. Let money find its own level gradually and not the nightmare that may disrupt prices,” the source said.

“The only thing is we don’t know the weighted average period of most of the loans, those who have given long-term loans are exposed which this time I believe are the larger banks,” the source said.

CBK has ordered all bank executives to submit monthly capped interest returns from November 7 when the cap was repealed, monthly data on new loans and customer complaints by January 10 next year.

It also wants them to march to Haile Selassie Avenue and demonstrate how they will implement the Banking Sector Charter (BSC) where the regulator wants banks to make changes including using information from Credit Reference Bureaus to give rates based on risks and not use a flat rate and publish all hidden charges.

The BSC is a commitment from banks that they will practice responsible and disciplined banking which is cognisant of and responsible to customer needs.

For digital products, provision of an abridged version of the terms and conditions to consumers using Unstructured Supplementary Service Data (USSD) format is critical before acceptance of the product.

CBK will use mystery shopping surveys and on-site checks to ensure compliance.

“We will be contacting you to confirm the date and time for a presentation and the engagement of your implementation plans towards the tenets enshrined in the banking sector charter. The chief executive officer should lead their respective teams for engagement with CBK,” Mugo said.

However, the price of government borrowing is likely to be the biggest determinant of lending rates given that banks compete with the National Treasury for deposits in the market.

Out of the Sh2.9 trillion domestic state debt, banks hold 54.2 per cent, pension funds hold 27.9 per cent, while insurance companies hold 6.4 per cent.

This means that banks will have to pay higher rates for deposits to convince fund managers to offer them money and not lend to the government. Higher costs of funds will then be transmitted to the ordinary borrower.

Controlling the rise of rate caps from pressure by the government to borrow is Dr Njoroge’s main job. He believes he is in charge, but bankers are giving him a blinking contest in a rare confrontation.

Following the enactment of the rate cap in September 2016, interest on domestic credit dipped as banks flooded government securities market while avoiding lending to the private sector.

This set off three years of cheap credit for the government on the domestic market that saw Treasury ramp up domestic borrowing from Sh1.8 trillion in June 2016 to Sh2.9 trillion in this year.

Dr Njoroge says suspended Treasury CS Henry Rotich’s abracadabra budget was responsible for this sorry state, but that going forward, Treasury has committed to cut borrowing.

“It’s not the first time we have had a conversation with the National Treasury. I’ve been here four-and-a-half years now. But I think for the first time, we believe in the fiscal consolidation taking place. Revenues in the past were over-stated, completely over-stated,” he said.

He believes that since Treasury can only borrow Sh300 billion locally, banks will have no option but to accept lower rates or he will reject their bids.

However, in Rotich’s budget, Treasury is expected to raise revenues of Sh2.1 trillion and spend Sh2.7 trillion, filling the gap with Sh634 billion in debts after grants of Sh38 billion.

But in the revised budget, CS Ukur Yatani has reduced revenue targets to Sh2 trillion and raised spending to Sh2.8 trillion. Thus, with a wider gap of Sh753 billion, Treasury will break the earlier plan and borrow more locally. Banks seem to be only too aware of this fact.

Banks vulture on Treasury’s desperation for money to increase rates since they now have the option of deciding on whether to lend to the State or private sector after the rate cap repeal.

Already, banks bids have pushed up the 91-day bond from 6.4 per cent at the end of October to 7.2 per cent last week, 182 day bill from 7.2 per cent to 8.2 per cent and 364-day from 9.7 per cent to 9.8 per cent by reducing demand, with last week’s average bids clocking to 34 per cent to attract a premium.

Government’s Sh50 billion 10-year bond was also under-subscribed at 76 percent, raising Sh38.3 billion at 12.4 percent.

“When 66 per cent for the market does not show up at your T Bill auction, then you know the market does not believe the story of your fiscal consolidation or they believe you’re lying,” a source said.

By cutting the CBR from nine per cent to 8.5 percent, CBK hopes to encourage banks to buy the current bonds since this move in an ideal market reduces the value of future bonds.

CBK also tricked investors into handing the National Treasury Sh68 billion for a 16-year bond by promising the markets will set prices only to fix a lower rate to help government keep the cost of debt low.

In the prospectus of the tax-free infrastructure bond, CBK had said return on the paper would be set by an average of the market bids, but pulled a fast one when it set a lower rate discounting the value of the bond.

Investors poured in Sh86.9 billion to chase the offer setting their asking price at an average of 12.5 per cent.

CBK, which was looking for Sh60 billion, accepted a higher figure of Sh68 billion whose average rates was 12.3 per cent. But without explanation, CBK put the coupon, the rate of interest paid annually, at 11.7 per cent taking investors by surprise.

“It’s the first time they have pulled such a stunt; it sends a wrong signal to the market because it is a default on the promise in the prospectus,” financial analyst and director at Callstreet Investor Relations George Bodo said of the move.

Removal of the caps may have pleased the International Monetary Fund, which has offered to give Kenya a new standby facility next year, but it has exposed the market to higher rates.

Even as Dr Njoroge becomes the defender of Wanjiku against greedy banks, his moves are about to be tested both legally and attacking his Achilles’ heel which is Treasury.