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Banks do not sabotage economies

A man and his wife owned a very special goose. Every day the goose would lay a golden egg, which made the couple very rich.”Just think,” said the man’s wife, “If we could have all the golden eggs that are inside the goose, we could be richer much faster.”So, the couple killed the goose and cut her open, only to find that she was just like every other goose. She had no golden eggs inside of her at all, and they had no more golden eggs.
The Sunday Nation on March 4th 2018 published an article titled “New credit law to help small firms”. The article featured a debatable quote from the Member of Parliament for Kiambu constituency Mr Jude Njomo who shot to the national limelight with his successful Banking Act (Amendment) Bill 2015 that capped interest rates for Kenyan banks.Close to a year and a half later, with credit in the economy at an all time low and a significant drop in the profitability of the entire banking sector, Jude Njomo was quoted as saying,“The credit squeeze to SMEs is a deliberate effort by commercial banks to sabotage the economy so that the government may influence Parliament to remove the interest rate caps.”

Parliament was about as smug as a bug in a rug when they passed the interest rate capping law. The collective view was that banks needed to be taught a lesson and to be dictated to on how to do business. However, the reverse happened. Banks simply stopped lending as it was not worth the risk and the funds that were meant to fuel the economy through lending for working capital and capital expenditure simply moved to the safest borrower of all mankind: the sovereign.

Mr. Jude Njomo and his legislative colleagues need to be disabused of one notion: You cannot juxtapose the word “banks” to the words “sabotage the economy” and expect a logical outcome. If anything, that is a fairly fallacious theory. It is about as oxymoronic as placing the words “parliament” next to the words “bans salary increases for lawmakers”. The two concepts are mutually dependent. Banks need a thriving economy to ensure that there is credit uptake and that those credit facilities are repaid which obviously leads to profitable business. Parliament need never set a ban for legislator salary increases because…well you can fill in the blanks yourself on that one. Aesop’s fable above summarizes it well, one does not kill the goose that lays the golden egg.

Credit is the lifeblood of any economy. Banks take in deposits and use the same to lend out to various sectors based on how much of their own capital they have in the business, what is termed as risk based capital allocation. Lending to the sovereign via treasury bills and bonds consumes minimal capital while lending to Tom, Dick and Harry consumes maximum capital. As banks by nature of regulatory rigour require a lot of capital, their shareholders will demand a significant return on that capital and lending to the ordinary mwananchi is the surest way of sweating that capital more efficiently. In a speech to the Kenya Bankers Association Banking Research Conference last September, the Central Bank Governor Patrick Njoroge reminded the banks about why they were in the position they were in. “There has (sic) been concerns about the Kenyan banking sector’s high average ROA of above 3% and ROE of close to 30%, when compared to similar economies….In any case the high ROAs and ROEs are not sustainable in the long term as customers cannot afford the high cost of banking services indefinitely.”

The Governor has been consistently rapping the knuckles of the Kenyan banking industry and the intervening period between the interest rate capping bill becoming law and its impending demise requires banks to significantly change their mindsets away from the traditional lending models to more innovative ways to make income as well as assess borrower repayment capacity (the fintechcredit algorithm methodologies for non-secured lending are a case in point). The Governorin his speech categorically pronounced the regulator as a key supporter of lenders that are fairly priced, lenders that provide differentiated risk-based pricing based on a borrower’s history and lenders that disclose information in a transparent manner. Legislators needs to be alive to the regulatory premise as the basis on which they should hold the banking industry to account, and not through reckless statements that the banking industry is in any shape or form killing its own economic golden goose.

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Twitter: @carolmusyoka

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IFRS 9 knocks the wind out of banks

[vc_row][vc_column width=”2/3″][vc_column_text]Banks just can’t catch a break, can they? In December 2015, Honorable Jude Njomo introduced a bill to ostensibly tame obscene profits that banks in Kenya were deemed to be enjoying. Having appealed to the hearts and pockets of his fellow legislators, who had unfettered and exclusive access to their own parliamentary low rate mortgages with a Kshs 20 million limit, free car privilege for the first car and Kshs 7 million low rate loan for the second car, the interest rate-capping bill sailed through and was signed into law in August 2016.

The mischief that the legislators should have sought to cure was the undifferentiated risk pricing that banks were levying on borrowers. A borrower who had a long history of taking loans and repaying them successfully would be charged at the same rate as a new borrower with zero credit history, which was in the range of 19 to 30 per cent depending on the bank.

What Honorable Njomo had no idea was the double whammy that banks were going to get once the International Financial Reporting Standard 9 (IFRS 9) replaces the International Accounting Standard 39 (IAS 39) with effect from January 2018. IFRS 9 aims at helping banks become more rigorous and prudent in the management of their existing stock of loans by setting an even higher standard on the amounts they must set aside as provisions for those loans, what accountants call impairment. While the previous standard IAS 39 required banks to make provisions only if the client started to demonstrate loan repayment stress, in other words reactively, IFRS 9 requires banks to look ahead, anticipate repayment stress and start making the provisions from the first day that the loan is booked.

What does this mean? Say John has a credit limit of Kshs 1 million issued on 1st January 2016. Under the previous standard of IAS 39, if he did not demonstrate any repayment stress then there was no requirement to set aside a provision for his loan. However, at the first sign of stress, say for instance he was retrenched and missed a payment that was due on 30th April 2016, the bank would be required to assume a probability of default of 5% from May 2016 and a provision would have to be made. Under IFRS 9, that probability of default has now been increased to a mandatory 10% in the first year of the loan whether or not the customer has demonstrated repayment stress. It doesn’t end there. There is an assumption that if John has a loan limit of Kshs 1 million but is only currently utilizing half of that, the unutilized portion of that loan is also included in the calculation for impairment. Thus the mandatory provisions for all loans regardless of their performance, as well as the inclusion of unutilized facilities means that the provisioning can go up to three times or more of the amount required before IFRS 9 standard was applied. This therefore applies to customers with credit card facilities or for those business borrowers who have working capital facilities like overdrafts or revolvers that tend to have fluctuating amounts during their lifetime. It gets even better. Even unutilized off balance sheet items like letters of credit and guarantees largely used by business borrowers, which previously did not need to be included in the calculations for provisions will now be required to be incorporated in the total calculations.

Simply put, banks will have to set aside income to create a bigger buffer for the loan stocks they have on their balance sheet, whether that committed loan is fully drawn or not. Setting aside that income can only be mitigated either through pricing, reducing availability of undrawn limits or both. Whatever the case, the current interest cap at 14% ensures that the pricing option is simply unavailable on most existing facilities. The danger that now lies on the horizon come January 2018 is that even overdraft and trade facilities that were previously being enjoyed by the privileged few business borrowers that survived the Njomo chop, will now either be removed or renegotiated as to be available on application rather than on available on standby as is currently the case.Trade is the oil that drives the economic engine of a country. When the instruments that enable that trade such as overdrafts, letters of credit and guarantees are imperiled, we can no longer make banks the whipping boys of our warped sense of social injustice.

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Twitter:Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]