Lenders urge law change to raise private sector lending

A new report has recommended new ways for banks to increase corporate lending amid growing worry about the crowding out of the private sector in the domestic credit market.

Repealing or amending laws in the corporate debt space is one of the policy recommendations in the study that examines the effect of government borrowing on private-sector credit.

The crowding-out effect happens when the government borrows heavily from the domestic market to the extent that banks shun lending to the private sector due to the security associated with sovereign debt and the expected returns.

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The study emphasises the need for public-private partnerships (PPPs) to reduce the State’s appetite for domestic debt, which would allow businesses and households to borrow.

The study notes an almost non-existent relationship between banks’ investment in private securities and sovereign debt while recognising how detrimental domestic sovereign debt is on private sector lending.

The detailed non-existent effect has been linked to a corporate debt market yet to be maximised.

The study proposes changes in laws and the judicial system to encourage the uptake of securities offered in this space by banks. It infers that litigation costs in this space are hazardous to corporate debt growth and even proposes lowering fees.

Lack of experts conversant with the sector is also a major issue, according to the study.

“Repealing and amending laws that impose stringent requirements on pension funds portfolio,” reads one of the policy recommendations.

The study recommends strengthening the legal recourse while calling for a reduction in litigation costs.

“Empowering regulatory agencies with qualified and experienced staff and investigative and enforcement powers that match the size of and complexity of the markets that they oversee,” reads the study.

While sovereign debt was found to have a direct correlation with banks’ lending to the private sector, which is said to hurt the economy, it has almost no effect on banks’ investment in private securities.

The study sought to determine whether debt sustainability has a discernible relationship with private credit growth.

The study notes that the negative relationship between the two is stronger during periods of debt unsustainability.

More importantly, the study purposed to find out if there is a threshold level of sovereign debt at which the negative relationship worsens.

It established the crowding-out effect, which is a phenomenon where loans and advances to the private sector are diminished due to government borrowing from the domestic market.

It states that anecdotal evidence shows an increase in Kenya’s usage of sovereign debt over the last few years, causing several of the country’s indicators of debt sustainability to label the situation as unsustainable.

“Further, credit terms have worsened considerably with Treasury bonds rates increasing to more than 17 per cent by the end of 2023,” the study states.

“Amidst these changes, lending to the private sector appears to be on a declining trend, while lending to government is growing.”

But while sovereign debt is squeezing out private sector lending, causing a negative effect on the economy, the study had several theories as to why the same is not happening on banks’ investment in private securities.

“These effects are stronger for loans and advances to customers than they are for private security holdings of banks, which can potentially be explained by risk asymmetry between private bank borrowers and security issuance of corporates,” says the study in part.

It states that there appears to be a one-way relationship between private security holdings of banks and direct private sector lending in which the former negatively affects the latter but not vice versa.

“That is, Kenyan banks appear to maintain, usually a minimum level of precautionary purposes of private-sector issued securities regardless of the level of their direct lending to customers but, over time, adjust their holdings above this level upwards or downwards, say for speculative purposes, financing their varying positions with funds that would otherwise be invested in loans and advances,” the study says.

It found that the relationship between sovereign debt and banks’ holdings of private securities is less pronounced and in some cases, particularly when sovereign debt proxied by the State’s domestic borrowing is non-existent.

“This study finds that the effect of government debt, particularly domestic debt, on bank investment in private securities is muted,” the study says.

 “This is likely due to the country’s small and illiquid corporate debt market that avails limited opportunities and other institutional investors.”

It further calls for policy measures that encourage capital markets viability such as strengthening legal and judicial systems for investor protection, promoting greater respect for market autonomy and enhancing regulatory independence and effectiveness.

The study details that although the debt growth nexus has not been examined in the document, evidence suggests that excessive usage of sovereign debt as it is in Kenya might be detrimental to the economy.