Domestic borrowing to blame for SMEs credit crunch

Monday, September 16th, 2019 19:48 |
Loan. Photo/Courtesy

Finally, the narrative pushed by banks that interest rate cap is responsible for the credit crunch facing  Small and Medium Enterprises (SMEs) has been effectively debunked.

 Speaking in Nairobi last week, Nigel Smith, the Head of debt advisory at audit firm, KPMG, asserted that the interest rate cap was not to blame for refusal by banks to lend to SMEs. 

Instead, he laid the blame squarely at the feet of government through its heavy borrowing from the domestic banking sector.

In recent years, Government’s appetite for borrowing from the domestic market has gone up exponentially, as its budget deficit expanded.

That this borrowing has tesselated with the interest rate cap regime is probably more coincidental than consequential.

What has happened is what economists called crowding out of the private sector. It works like this. Government borrows from the domestic market by issuing Treasury bills and bonds.

When it wants more money from the domestic market, it makes those bills and bonds very lucrative, to the extent that the interest rate offered is now competing with that at which banks lend to businesses. 

Given that default by government is seen as near zero, banks can through a simple transaction buy huge amounts of Treasury bills and sit pretty waiting to reap interest without a sweat.

Businesses cannot compete with government. That is why, as an economic imperative, governments are always urged to reduce their borrowing from the domestic market, to give room for businesses to get credit for growth.

It is not just SMEs that are suffering the credit crunch, it is the whole economy.

It is now clear that the narrative about the rate cap has merely been self-serving. The rate cap is innocent.

As long as the government does not tame its appetite for domestic borrowing, removal of the rate cap will have zero effect.

As lending interest rates rise, the interest on T-bills and bonds will simply keep pace!

Indeed, the rate cap has brought stability and predictability to businesses and tamed capriciousness by banks.

It has forced banks to look afresh at their cost structures and dismantled the “follow the leader” business model existing before the rate cap. Now all banks are on their own.

Treasury Cabinet secretary Ukur Yattani was in Parliament last week to sell the idea that the rate cap should be repealed because it is hurting SMEs. Skeptical MPs were not convinced. 

The government is losing precious time fighting the rate cap. It should use the reprieve provided by the current rate cap environment to remodel the financial sector in general and the banking sector.

 Banks would like it believed that before the rate cap, they easily lent to SMEs because they could price presumed “risk” into the interest rate charged. This is a piece of fiction.

SMEs have always faced disdain and prejudice from the banking sector. A liberalised interest rate regime will not cure an attitude problem.

Three things must be done if really the issue is to make credit accessible and affordable for SMEs.

The government needs to facilitate the emergence, strengthening and broadening  of the microfinance sector, including making regulation more robust. 

Microfinance institutions (MFIs) have been the real financial intermediaries for SMEs. They understand SME needs, are nimble and lean enough to engage them at their level, and are creative when it comes to collateral. MFIs have embraced SMEs wholeheartedly.

Secondly, the government must reduce its appetite for domestic borrowing to  free funds to the economy. This is the magic bullet. The government’s announcement last week that it intends to cut its deficit by 2020 is a bridge too far. The situation is very urgent.

Lastly, the long pending payments are critical to this equation. A lot of SME credit is predicated on Government LPOs, yet government delays payments for years, making these businesses a bad risk.

Government must make its payments predictable, and within a reasonable time frame. This will open a huge pipeline for SME credit from a plethora of financial intermediaries. 

These are the areas Yattani should be expending his energies on, if he really wants to be the CS that removed the economy from recession.

He might then even convince Parliament that the rate cap is no longer necessary. [email protected]

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