Bank-Kenya - Loosening commercial banks' tight grip on the government bonds market will help to lower borrowing charges and boost lending to the private sector, permanent secretary in the Ministry of Finance, Joseph Kinyua, has said. Kenyan banks currently hold more than 55 per cent of treasury securities, a stranglehold that the government feels has encouraged them to retain high lending rates as they enjoy high returns from the risk free investments. Bond market reforms which the government plans will, however, see the establishment of a bond market structure that will limit direct selling of treasury securities to deep pocketed local and international investors, in a move expected to lessen the lenders' control of the sector. "The effort to improve the bond market by implementing reforms that deepen and widens the range of individuals and institutions to invest in bonds may contribute to reduction of the current unacceptably high interest rate spread," said Mr Kinyua on Friday.

The current 30-year treasury bond is paying a return of 12 per cent, making the banks reluctant to cut their lending rate to the private sector below this threshold.

Small banks currently charge the highest average lending rate of 14.82 per cent while large and mid-sized banks give loans at 14.66 and 13.35 per cent respectively.

The government hopes that the move to reform the bond market will push the banks to lower their lending rates and hence reduce the interest rate spread, which stands at about 10.51 per cent according to CBK data for February.

The banking sector reported a near double growth in after tax profits to Sh72.4 billion last year helped by the high interest rate spreads - the difference between borrowing rates on loans and the deposit rates.

The lenders are expected to start competing for treasury bond sales in the secondary market as most may not meet the capital requirements to become primary dealers.

Under the current system all investors bid directly for government securities with the Central Bank of Kenya (CBK) and this has given banks an easy way to make profit and steady income through risk free securities, making them reluctant to lend to borrowers considered risky.

Mr Kinyua said the reforms, which include the establishment of an over-the-counter market for bonds and treasury bills, are also expected to boost bond turnover - further deepening the market - which according to the Nairobi Stock Exchange (NSE) hit a high of Sh493 billion last year.

Though the government has not yet disclosed what level of capitalisation will be required, it is expected that many banks might not meet the high capital thresholds required to become primary dealers.

Selected primary market dealers will be required to be highly capitalised to absorb entire government debt offerings.

Revenue shortfalls

Treasury increased this year's domestic borrowing target by Sh20 billion to Sh125 billion as the Kenya Revenue Authority reported tax revenue shortfalls amid growing government expenditures due to drought and implementation of the new Constitution.

The government also hopes that the reforms will spur increased turnover through a hybrid bond market, which will include trading over-the-counter and through the NSE, thus increasing the bond turnover to gross domestic product ratio.

Treasury bonds turnover increased to 17.5 per cent of GDP last year from 5 per cent in 2009, though Mr Kinyua said it is "well below international standards" compared to other African countries such as Nigeria whose bond to GDP ratio is at 32 per cent.

He said that the hybrid bond market structure "is expected to improve price discovery and turnover of the bond market and help us move towards achieving our target of 30 per cent of GDP by 2012".

The reforms will also see the CBK adopt online bidding for institutional investors and the creation of agency arrangements for retail investors and direct participation by non-institutional investors in the primary market.

The online bidding by primary dealers will see the time lag between bidding, auction and when the bonds begin to trade reduced as opposed to the current paper-based system.

David Mugwe

Business Daily/11/04/2011