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”.

A Mechanical Tool for a Structural Problem - ICPAK Edition

My first economics lesson in high school decades back was on the subject fancily referred to as "market structures". My teacher, Mr. Stephen Mugenyi, started by telling us that there are three types of markets - monopolistic (one market player), perfectly competitive (many players), and oligopolistic (in between the two extremes).That was a mouthful.

The following day, he went on to tell us the features of each of the three. A monopolist has total market power and plays in a market with entry barriers. A monopoly makes 'abnormal profit' based on the ability to restrict output and therefore charge high prices.
In a perfectly competitive market there is free entry and exit, and market players make 'normal profit' as the market dynamics enable prices to adjust to a common level.

As I came to learn later (as I grew to become a professional economist), monopoly and perfect competition are two extremes - what we later used to call "corner solutions". The real world is somewhere in between, and that is the oligopolistic structure. [there is also monopolistic competition; I didn't learn this from Steve]. In an oligopolistic set up, there are either few players or a few dominant players.

If one wants to move the market towards perfect competition, one needs to look at one variable: number of players - not simplistically increasing such number but ensuring that that market dominance is not by few players (in other words expand the top).

Even this will not lead to perfect competition; it can only approach but not attain perfect competition status (we used to  romantically refer to this as an "asymptotic process"). You cannot move an oligopolistic market towards perfect competing through attempting to fix the price. That is because, the reason you have oligopoly is "structural".
Now, the Institute of Certified Public Accountants of Kenya (ICPAK) leadership has chosen to argue that price controls will address a structural issue. They argue that the banking industry is oligopolistic, therefore cap interest rates will just do the magic.

This brings three things to mind.

• One, things that are expected to be obvious to some a group of professionals who are expected to be thoughtful and knowledgeable aren't usually so.
• Two, playing to the gallery is  very very tempting. I can't see the motivation though when it comes to ICPAK leaders on this issue. Is it politics? Well, I don't know. What I know though is that it is not economics!
• Three, there is a huge difference between simple solutions (carefully thought through but easy to implement) and simplistic (looking at which side of the debate is noisy and assuming that they have a point). ICPAK leaders present a typical simplistic solution. Not that there is a simple one when it comes to interest rates; but one expects logic in any conclusion and I see none of that in ICPAK's assertions.

Illiteracy in Basic Economics - Once Again!

When I saw the Daily Nation tell us today that the IMF calls for  interbank rate control in Kenya, I wouldn't help but recall that in the recent past I have asked (actually twice - here and here) whether the Nation Media Group has an economics editor. I guess I would have to go easy on the question and surmise that clearly they do not need one.

Why do I think so? Because the author of the piece hinges his sweeping observations on a recent IMF Working Paper. I happen to have read the said paper three days before the Daily Nation story was published. I would like to argue that:

• One, my reading was very careful because the paper is very technical but well written for a trained eye to enjoy [I didn't expect the Daily Nation reporter to understand what the hell the exponential generalized autoregressive conditional heteroskedasticity  (E-GARCH) specification is all about!].
• Two, the paper's conclusion - written in plain English nowhere suggests for a control of the interbank rate.
• Three, the habit of picking statements from a technical paper with the objective of fitting a particular narrative is very addictive in the media, especially when there is a desperate endeavour to appear knowledgeable on a subject where the reality is the exact opposite. 

I have a strong feeling that either the author doesn't - or chooses not to - understand  how the interbank market operates. So let me make no assumption here and observe as follows:

• First, the interbank market is an overnight market whose price (the interbank rate) is influenced by the overall liquidity in the market. 
• Second, the other money market rates such as treasury bill rates are a reflection of liquidity situation in the market and therefore have an implication of what the interbank rate could be.
• Three, (and this is for those technically inclined) the E-GARCH methodology allows for the determination of the direction of influence between the interbank rate and the treasury bill rate; and such influence can be dual (meaning the two influencing each other). The IMF paper indicates that such influence is strong from the interbank rates.
• Four, the interest of ensuring a smooth interbank rate that is coordinated by the policy rate (the Central Bank Rate[CBR] in this case) is such that the central bank could use the interbank market as an operational target for monetary policy - the CBR is the signal rate and the interbank is the operational rate
• Five, there are merits in the central banks creating a band around the CRB around which the interbank rate could fluctuate (the paper calls it a corridor). The narrower the corridor the better it is to manage volatility in the interbank market given that the CBK does not fluctuate frequently.

Does the proposal for the creation of a corridor amount to a call for controlling the interbank rate? Definitely not. The central bank can only seek to influence, but not control, the interbank rate. That is why, to let the IMF paper speak for itself, 

"by announcing a rate that it wishes to prevail in the overnight interbank market and ensuring its implementation through day-to-day liquidity operations, the central bank aims to influence and stabilize longer-term rates, important for overall level of prices and real economic activity. Likewise, the central bank’s ability to reduce volatility of overnight interbank rates should matter for monetary policy because interbank market volatility may

affect funding costs for longer-term financing".       

So where is the Daily Nation coming from with its screaming assertion about the call for interbank rate control? I do not know. I suspect it is a function of the implicit sympathy to have money market rates controlled - aligned to the silly proposal by the a section of the legislature - that the media house is shy of directly asserting.

But it all amounts to illiteracy in basic monetary economics.        

Non-economics!

Simon Wren-Lewis, one of my favorite academic economists, has a very interesting post on his blog on economic reporting without economics. I have been on this subject for a while now, but more explicitly in the recent past (see here and here).

At the very best, a new branch of economics has been "created" although it doesn't go through the formal route of rigour and logic, which Prof. Wren-Lewis cleverly calls media macro!

And still the posturing continues!

Does Nation Media Group have an Economics Editor? A Redux

I recently asked: Does Nation Media Group have an Economics Editor? This was not a pedestrian question. My motivation was that the media house makes unforced errors in matters basic economics.

In today's Business Daily, the lead story talks about inflation tax. The author talks about how proposed tax measures on financial services and consumer goods will lead to inflation. It is an accurate report, only that it does not amount to inflation tax, which is a technical word that means something else.

Am I splitting hairs? No. Instead I am illustrating how the pursuit of sounding informed by the media house often results in embarrassing inaccuracies.

If the report was about government measures that have an implication of raising medium term inflation, which then erodes the value of money - or bonds - it would be accurate.

Moral of the story: modesty - of words - is a virtue.  

What Hapenned to the Policy Reset Promise?

When I got an invitation from the IMF to attend a 9th May 2016 lecture by Its First Deputy Managing Director, Mr. David Lipton, at Strathmore University, I was excited. Part of the excitement was underpinned by the promised thrust of the lecture - Sub-Saharan Africa: Time for Policy Reset.

Is that what we got? Well, Mr. Lipton instead talked about "The Challenges of Sustaining Africa’s Growth Momentum". At the end of it all, the case for policy reset was not litigated; not even when the lecture ably navigated the terrain of remaining optimistic about the continent while being rife to the downside risks.

What struck me though was the celebratory tone that Mr. Lipton made reference to African economies' foray into the international capital markets. For what it is worth, I am all for a careful venture into the Euro bond market as well all other  capital markets but with one condition: the economies shouldn't do it as a matter of fashion; rather they should undertake a careful examination of the implications of such venture.

I honestly expected Mr. Lipton to provide some context on this subject, even from the wider perspective of debt sustainability, but he didn't; at least not explicitly.  What am I saying here?

• One, the  May 2013 issue of the IMFs Regional Economic Outlook for Sub-Saharan Africa has a brilliantly crafted chapter on Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa. In this publication is a list of Sub-Saharan economies that had issued Sovereign bonds in the international markets.
• Two, many of these economies are beneficiaries of the debt relief initiatives such as the HIPC and its enhanced version.  
• Three, these economies' venture into the international capital markets was premised on the argument that they were debt sustainable, at least based on the IMF-World Bank criteria.
• Four, it can be argued that without relief, these economies could have not have been deemed debt-sustainable; in other words their debt sustainability was a function of somebody else's benevolence and not their debt management ingenuity.
• Five, given the downside risks that Mr. Lipton ably pointed out, and consequently the gloomy outlook of Sub-Saharan Africa as illustrated by the IMF's latest Regional Economic Outlook, some of these economies are heading back to debt unsustainability.

One question then comes to mind: if these economies get back into debt unstainable positions - and there evidence that some could - is a new form of debt relief the policy reset that the lecture didn't allude to?

I don't know. All I know though is that Mr. Lipton brilliantly  set the base for an interesting engagement; however  the discussants who were meant to motivate the engagement were at best underwhelming!