Interest Rate Capping: Muthoni Thang'wa an Innocent Victim of the Dunning-Kruger Effect

One of the luminaries in Kenya’s financial sector recently wittily quipped that on the subject of interest rate capping “everyone and his/her cat” has an opinion. And he was right.  Ms. Muthoni Thang'wa has very strong opinions on the matter as expressed in her Op-Ed in today’s Daily Nation.

Ms. Thang’wa’s short bio in the Daily Nation indicates that she “works in the heritage sector, specialising in culture and enterprise”. That does not deny her the right to have an opinion on this subject. It however makes one wonder whether she knows what she is talking about when she asserts thus:

“It has been proven, economically and mathematically, that banks will make profits on loans at the current regulatory rate of 14.5 per cent, yet they charge up to 11 per cent more than this rate. This greedy difference is what this law seeks to regulate”.

On this I can only ask one question: where is the study? I suspect that there is no study she or any person of her persuasion has done of the matter. If there was such study, she could have been all over town with it.

But then again I know how those who earn a living out of pontification operate. They simply take leave of logic and reason if that will come between their preconceptions. In other words they have attitudes that they desperately seek to justify through sounding profound but not making any sense.

It gets juicier when Ms. Thang'wa argues thus”.

“All the players in the financial sector take the public for granted; none of them had any research or data that supports any of the claims they used to oppose the Bill, including inefficiencies in the credit market and credit rationing”.

Really? No studies? I argued yesterday that there is a group of people whose arguments on this subject can be characterised as “accidental expertise”. If Ms. Thang'wa is the reading type, she can see the link on my blog post to a World Bank Paper that could easily rubbish the arguments in her Op-Ed.

Let me make it easier for her by saying that the financial sector knows a lot on this subject than she imagines. And that knowledge is based on experience and, yes, research.

Let me not speak to experience because that is a subject on its own that portrays Ms. Thang'wa’s attitude seeking dubious justification. Such attitude is such that:

(a) she knows more on the subject than the Central Bank of Kenya (CBK) which has opposed the capping of interest rates as a way of addressing the structural issue of high interest rates
(b) she knows more than the National Treasury, on the subject whose view on the matter is the same as the CBK’s
(c) she knows more on the subject than the Deputy Managing Director of the International Monetary Fund (IMF) who recently argued that “Another challenge facing many African countries is the persistence of very high spreads between the interest rates offered on deposits and those charged on loans. This has led to understandable frustration among borrowers about the cost of credit, and has produced political pressure for interest rate controls. However, the politicization of monetary policy bears well-known risks—for the soundness of the financial system and for credit access, notably higher-risk borrowers. International experience suggests that, in many cases, interest rate controls may actually end up reducing access to the banking system for small borrowers—such as farmers, SMEs and consumers—and may also revive informal lending at much higher cost for borrowers”.       

Instead let me speak to research conducted by the financial sector in Kenya.

·         We know through research that the Kenyan banking industry exhibits strong competitive attributes. So if interest rates are sticky at high levels it has less to do with competition and more to do with exogenous factors such as huge government fiscal deficits financed through domestic borrowing. That study is available here.

·         We know through research that the challenges that exists in the interbank market (yes, no assumptions here that Ms. Thang'wa knows that there is a credit market amongst banks!) are structural and could be compounded by capping of interest rates. That study is available here.

·         We know through research that banks are strategically positioning themselves to support capital markets deepening through their investment banking subsidiaries; therefore strategically they are diversifying away from interest income towards entrenching transaction and advisory based income. That study is available here.

·         We know through research that the challenges of SMEs are wider than financing, although Thang'wa et.al. would want to make it appear that finance is the only problem of SMEs. That study is available here.

I can go on and on and on about the studies on matters finance, banking and economic policy by researchers in the financial sector, but I guess it cannot help persuade Ms. Thang’wa to move an inch from her jaundiced view. I need to say this though. The fact that she doesn’t know about the existing research does not excuse her empathic assertion that there is no body of knowledge on this subject and more.
What it does it bringing out the possibility that Ms. Thang’wa could be an innocent victim of the Dunning–Kruger effect, which is a perception bias whereby low-ability individuals suffer from illusory superiority, mistakenly assessing their ability as much higher than it really is.

Interest Rate Caps, the “Accidental Expertise” and Our Version of Donald J. Trump

In April 1999, economist Paul Krugman published a small book with a big message. The book is titled “The Accidental Theorist and Other Dispatches from the Dismal Science”. I recommend it to anybody keen on understanding why in economics and in business, relationships are not always linear.

I have my doubts though that many of those who this small book (yes, it is only 204 pages) should realty help could even touch it because it has the world “Theory” in its title.  I guess it is because they consider themselves to be “practical”.

My understanding of practical men is shaped by Lord John Maynard Keynes who, in the last Chapter of his Magnus Opus – The General Theory of Employment, Interest and Money – noted thus:

“The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist”.

 The “practical” men and women are now telling us that all will be fine with the interest rate capping, and that they have done “their research” which points them to a WorldBank report that concludes that the practice is all over. Their inference is therefore that the practice must be beneficial. If only that was true! But it isn’t. The report says exactly the opposite; but then who – among the “practical" people – cares about the truth in this logic-free, fact-free interest capping regime? Indeed who cares to read a 40-page paper whose main conclusion is contrary to ones prejudiced position?

That is not where it ends. The “practical” people are telling us that the “greedy” banks (remember Gordon Gekko in the movie Wall Street?) will do all they can to keep their levels of profitability. In other words, their greed will push them to lending more; in any case, they argue, with low margins banks will be “forced” to lend much more.  In other words, to them the credit market is like the potato market.

If I was talking to my fellow “’non-practical” people, I would say that the “practical” side assumes that credit demand is price elastic. And they are wrong. Consider this: walk into The Junction Mall in Nairobi and see two banners. One of the banners is by a bank – pick any, for there is NIC Bank, Commercial Bank of Africa, Standard Chartered Bank, etc. – and it says that you can get credit at 14.5%. The other banner is by Nakummat Supermarket and it says that you can buy one kilogramme of potatoes at Kshs14.50.  

With Kshs14.50 in your pocket, you can walk to Nakummat and stroll out with your bag of potatoes. Just as you find that the price of potatoes in Nakummat is competitive, you would be on the idea that credit is now competitively prices thanks to the capping law. With your potatoes in hand, walk into the nearest bank and apply for credit.

It may not take as short a time as buying the potatoes, but the bank will make a decision either way. If the appraisal process shows that your credit risk is larger than the cap, then the bank will make the decision of not lending to you.  Under no capping, the bank will make an offer of a rate that matches your risk profile; but what the capping law does it make it illegal to lend to people of a certain risk profile!

I guess being “practical” simply means that you ignore even the very basic truth that many households and small business are constrained more by access to credit than the cost of credit. This by no means suggests that cost is irrelevant; it simply means that if you come up with a blunt tool such as capping to address costs, you may end up frustrating access.

Will the low margins mean increased credit so that Mr. Gekko can quench his greed? The answer is in a document that many “practical” people  haven't read – while posing as experts in matters banking when in fact their lives revolve around the equation Assets = Capital + Liabilities – ; that document is called the Central Bank of Kenya Prudential Guidelines.

For those too busy being “practical” to read the Prudential Guidelines, they provide for how much a bank can lend for a given level of capital. So more lending demands more capital, if price is restricted. But what happened when the capping law was signed tells anybody careering to look at this matter intelligently that capital was the first variable to quickly move – the listed banks’ stocks simply crashed.

So therein lies the “accidental expertise”. It doesn’t surprise me therefore that leading media houses wrote celebratory editorials about the capping law even as the bank stocks where their staff pension funds are invested collapsed. Nor does it surprise me that even respected business newspapers such as The Business Daily is treating its readership as if it all have a one-day memory on this matter.

 If not having a Donald J. Trump mentality of switching positions daily, what can explain the following switch?

July 28, 2016 Editorial: “The Kenya Banks Reference Rate (KBRR) for example was a brainchild of intense the banks lobby as it sought to calm MPs who were at the time baying for the lenders’ blood. The widely discredited rate again did not move a needle on the interest rate charts, but has been used as political tool to appease any critics of the high interest rates”.

September 14, 2016: Editorial:  “For instance, the CBK waited till the very last minute to speak to the key issue of the base rate that would be applicable in the pricing of loans as the new law requires. When it did, it chose the Central Bank Rate (CBR), an instrument set by armchair economists in boardrooms instead of the transparent and market driven KBRR – and felt no obligation to tell Kenyans what informed that choice”.