SME

The effect of the interest cap on monetary policy

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This article first appeared in my weekly column with the Business Daily on March 12, 2017

Last year I opposed the interest rate cap before it was approved and came into effect. I opposed it because I knew it would lead to a contraction of liquidity, particularly for SMEs who are often viewed as high risk by mainstream banks. A few months later, the fears I had have become a reality. Last week this paper reported that Kenya’s private sector growth moved towards stagnation in February partly due to a decline in private sector credit. Treasury reports indicate that credit growth slowed down to the lowest level in a decade, partly due to banks becoming reluctant to lend under the rate cap regime.

As this paper reported, Treasury data indicates that lending to businesses and homes grew just 4.3 percent in the year to December, down from 20.6 percent in a similar period in 2015. The 4.3 percent credit increase is well below what the Central Bank of Kenya (CBK) says is ideal loan growth of 12 to 15 percent which is required to support economic growth and job creation

Image result for credit

(source: https://loanscanada.ca/wp-content/uploads/2014/10/credit-score-scam-1.png)

The irony of this situation is two-fold. Firstly, the interest cap did not expand lending, it contracted it, particularly for SMEs. Strathmore Business School indicates that most SMEs in Kenya struggle to raise capital from banks. With rate caps, refinancing of credit from financial institutions has become even more of a challenge. Secondly, even with the interest rate cap, most SMEs find current interest rates unaffordable. Credit is still too expensive.  So what did the interest cap achieve? Firstly, it has made it even more difficult for SMEs to get access to credit and secondly, it is an effort in futility as credit is still too expensive for most, even with the cap.

This is when monetary policy would usually come in to try and address the situation. In a normal scenario with no cap, a contraction in liquidity would usually lead to a drop in interest rates to encourage banks to lend. However, the CBK would not do this due to two reasons. Firstly, the ongoing drought is already placing upward pressure on inflation; the overall inflation rate for February this year was 9.04 percent, well above the ceiling of 7.5 percent. Thus even in a normal situation, the CBK would likely not drop rates as this would place further upward pressure on inflation. Secondly, this is an election year where billions enter the economy in an almost artificial manner, putting further upward pressure on inflation.

Image result for SME Kenya

(source: https://i0.wp.com/covered.co.ke/blog/wp-content/uploads/2017/02/sme-banking-e1479992621937-1024×857.png?fit=810%2C678&ssl=1)

However it is not business as usual, there is an interest rate cap to contend with. The interest cap has thrown monetary policy into chaos. In the current situation, the CBK cannot drop interest rates to encourage lending as this would engender further contraction in liquidity, shutting even more people and businesses out from access to credit. Lowering interest rates would make banks even more reluctant to lend. So the irony of the situation is that it appears that an increase in interest rates may encourage more lending from banks as it would raise the risk ceiling of those to whom banks are comfortable lending. Kenya is in an interesting position where increasing interest rates may actually expand lending; monetary policy has to work upside down. However, if the increase in interest rates were effected to try and address the contraction in liquidity and worked, it may then exacerbate the inflation being caused by the drought. Even in this upside down world there are reasons against raising interest rates as well as dropping them. Raising interest rates would likely expand liquidity and exacerbate inflation and dropping rates would likely engender a further contraction in liquidity.

The world is watching this experiment with interest rate capping going on in Kenya, and thus far it is making the case against interest rate caps even stronger.

Anzetse Were is a development economist; anzestew@gmail.com

 

 

 

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Are Kenyans afraid of Equity Financing?

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This article first appeared in my column with the Business Daily on July 10, 2016

As an independent economist and consultant I have the opportunity to do interesting research and analytical work in the country, region and continent. Recently, I have been interviewing numerous individuals and organisations on what constraints negatively inform the economic development of the country. One issue I seem to bump into regularly is the financing of businesses in the country. I always hear about how access to finance is an issue for most businesses, particularly SMEs.

The general complaint is that the conditions of financing, particularly the onerously high interest rates, negatively inform access to finance from SMEs- and I agree. In order to meet the demands of current interest rates, a business has to be ridiculously profitable from the second they get the loan in order to service the loan. As a result, SMEs across the country often resort to financing from mainstream channels as a last resort. SMEs will often start with raising funds from friends, family and informal financial channels such as merry-go-rounds, and only if these fall short will they resort to loans, and only if they qualify.

(source: https://www.newsghana.com.gh/wp-content/uploads/2015/02/wpid-US-injects-2bn-into-SME-development-in-Nigeria.jpg)

So given this state of affairs, one must ask: Are there alternative sources of finance for SMEs, particularly sources of finance that are more patient? And the answer is yes. Getting finance from equity sources ought to be seriously considered as the business profit schedule can be more realistic and there is no pressure to meet periodic and generally inflexible debt payments. Yet, there seems to an articulated reluctance in the Kenyan context to engage in equity financing.

For example, I was talking to someone who understands the equity space in Kenya and the USA. In the USA, private equity funds are sought after by businesses for financing. In Kenya however, the situation is different and it is not uncommon for equity players to have to take the initiative and actively look for projects that could qualify for their financing. Whereas demand chases supply in certain parts of the world, it appears that supply has to stimulate demand when it comes to equity financing in Kenya. I continue to hear players in the equity (and other) financing spaces complain that there is more money than there are bankable projects. Thus the irony seems to be that there is money looking for homes in Kenya but there does not seem to be a sufficient number of viable projects to absorb the money- unless investors aggressively seek out these projects.

So naturally my question is why? Why aren’t Kenyans positioning their businesses to better leverage equity financing? Equity tends to be more patient than debt, and given the fact that business in Africa can be unpredictable, why isn’t such patient financing more attractive to Kenyans? The resounding answer I got is control. Kenyan businesses seem to be especially reluctant to take on equity financing because they will have to cede a certain amount of control over their business to ‘others’. This predisposition is particularly strong in family businesses in Kenya, some of which are big players in the Kenyan business context. Rather than cede control to external investors in equity deals, many businesses would rather just maintain control and contend with the debt market. It seems as though many Kenyans would rather get a loan from a bank or just let their business bumble along at its current size, than cede board positions and crucial management decisions to ‘outsiders’.

Other factors that seem to discourage the uptake of equity is that debt is easier to access and firms are not put under great scrutiny as tend to be the case with equity deals. Further, there seems to be a lack of understanding of equity financing and how it can be leveraged for firm growth.

(source: http://www.getequityfunding.com/publishImages/index~~element54.png)

In some ways this is a shame because although I understand the predilection for maintaining control, if Kenyan businesses are hesitant to take on equity, this reluctance may be negatively informing the ability of businesses to expand and grow. We can all think of businesses, massive businesses, which have benefitted from equity financing around the world. So rather than associating equity with ceding control or being intimidated by the lack of understanding on this type of financing, perhaps Kenyan businesses should take a deeper dive into how equity can be of benefit to their businesses. After all, a diversified financing strategy can only be a good thing.

Anzetse Were is a development economist; anzetsew@gmail.com