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”.