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SMEs need to innovate to evade high interest rates

Financial innovationWith the base lending rate quickly rising, Adjustable Rate Mortgage (ARM) payers are as a result being forced to pay even more from their lenders. Although the lenders are justified how are the ARM borrowers expected to shelter themselves from these mounting bills?

All we currently need is a sound financial innovation. Sound financial Innovations that will enable us live and compete sustainably in this competitive money environment without foul cry.

Let’s put to consideration this ARM being a cash flow with two components, the fixed principal portion and the variable interest potion (which is determined by the base rate plus the borrower’s risk spread). A sound plan would be one that assists the client in preventing them from the high rates necessitated by the high base rates CBK has published.

For a company to be able to underwrite these kinds of swaps it should have the ability to devolve large liabilities in future. This is not going to be possible in Kenya, unless two things are made possible by the Central Bank of Kenya and other financing institutions.

The CBK must bring to action, the capability of STRIPING (Separate Trading of Registered Interest and Principal) of its bonds. By doing so, it will be creating the ability of bonds issued during high rate environment to be halted and traded later on when trade rates drop. In any case, if the rates go higher, short selling can as well be allowed so that the principal peril is mitigated by a long term sale of yields.

According to a stock analyst that was involved in creating an non-tradeable, direct consumer, LIBOR linked, fixed-for-floating interest rate swap, It was simple but properly innovated since it had a much wider variety applications as had been previously envisioned.

In the way it was structured, issuers were to pay whatever their floating rates, paying counter-party was liable for by entering into agreements to receive whatever that counter-party’s rate was at the time of execution plus a premium. Where global interest rates are low, they were hedging the counter-party from a rise in interest rates in the future, which was definite, since rates are almost at zero percent and when considering liabilities such as mortgages, the saving would be quite extensive.

In using a similar but inverse approach which is a simplified abstraction, we can assume that the lending rates are always high, and a reduction in these rates is expected. In comparison, an exact opposite product like this one could be created by financing companies in case the regulation allowed. It is worthless that such a product should contain an optionality clause which therefore allows the consumer the right to exercise.

The regulators, CBK particularly should allow such kind of innovations for any long-term floating borrowing whose interest rates are a function of the base lending rates. These could benefit from such kinds of products as mortgages, long term lines of credit among other financial aids. If by any chance the off-balance sheet derivatives were allowed, borrowers would be insulated from such high interest rates. Small-scale loans on the other hand can be securitized better by lenders as default rates would theoretically reduce therefore providing stability that would allow increased lending in the retail and SME segment for growth.

Image courtesy: FreeDigitalPhotos.net

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