By Sammy Grey
For most startups worldwide, they face the biggest challenge when it comes to scouting for avenues from which they can get their capital. Of these avenues, commercial banks and other financiers are the most sought after by many small businesses. In Kenya, however, the creditors have to contend with exuberantly high interest rates from these institutions.
Kenyan commercial banks enjoy interest rate spreads of about 11.4 percent on average, way above the world average of 6.6 percent. This has been the status quo for the past 20 years. This has not escaped the eyes of the Kenyan legislature as they have tried unsuccessfully to introduce restrictions that sought to cap the interest rates that the lenders use when issuing loans to creditors.
In 2001, there was an attempt to amend the CBK Act and cap the lending rates at four per cent above the 91-day T-bill and the deposit rates at 4 percent below the 91-day Treasury bill, bringing the spread to eight per cent. In 2013, the Kenya Parliamentary Budget office proposed the pegging of the deposit rates to the lending rates. The restrictions were unsuccessful in both attempts.
However, the latest amendment to the Bank Bill 2015 fronted by Kiambu North MP Jude Njomo was successfully. The Bill puts a cap on interest rates at no more than 4 percent above the indicative Central Bank rate. The passed Bill also sets the minimum interest earned by deposits at 70 per cent of the Central Bank rate.
The Bill was passed resoundingly and it just awaits President Kenyatta’s assent. The new development has caused jitters among commercial bankers who have described the Bill as ‘purely emotive and ill-advised’ that will cause severe repercussions to the country’s economy. In addition a spat is first ensuing between the National Assembly and the commercial lenders.
After all is said and done, however, where does that leave the creditors? What are the upsides and downsides to either adopting or dismissing the Bill?
The truth is that is the banking sector is a business that seeks to make profits. However, according to Hon. Jude Njomo, the banking industry is making abnormal profits as it is, thanks to an interest rate of 18 percent that is ‘disenfranchising’ the common mwananchi and the small businesses, which are the cogs in the gear wheels that drive this nation’s economy.
This correlates to findings done by World Bank early in March, this year, which found out that the high interest spreads that commercial lenders continue to enjoy at the expense of the rest of the economy is clearest indicator of lack of competition. In addition, the report stated that Kenyan banks have for a long time rejected reports of cartel-like behaviour in their midst that has seen Parliament make multiple attempts to regulate loan pricing by law. It also found that six banks out of the 41 operating banks in Kenya, have been classified by CBK as large lenders. These banks control half of the country’s total deposits, own 48 per cent of industry assets and booked 61 per cent of the profits. This notwithstanding, the commercial banks have come up in arms to protest the Bill and ask President Kenyatta not to assent to it.
According to experts from Cynnton Investments, the Bill goes against the very market forces of supply and demand. In any economy, banks act as an intermediary through which people deposit funds and get loans. So banks essentially make money from the difference between the rate which they pay depositors and the rate which they charge borrowers. These rates are determined by market forces, that is, demand and supply, but also several other factors come into play.
Placing a cap on interest rates will have an effect on the industry’s efficiency as it doesn’t account for several factors that might affect the banks decision to opt for certain spreads.
In addition, pegging it to the Central Bank Rate will depend largely on the transmission mechanism of monetary policy decision into the economy and the effectiveness of the Monetary Policy Committee in assessing the state of the economy. Experts have warned that capping the interest rates will see more creditors borrowing money in foreign currency, where the capping does not apply. This will go a long way in weakening the local currency and the economy.
Other countries have used interest caps as well. However, it was not for the control of spreads but rather to control extreme lending and borrowing behaviour. In such economies the cap is usually way higher than the prevailing lending rates. A great example is South Africa, where the cap on loans is 2.2x the repo rate plus 20 per cent.
Currently the repo rate is seven per cent, bringing the cap to 35.4 per cent, way above the prevailing commercial prime lending rate of 10.5 per cent.
Investment and financial experts are of the opinion that capping interest rates might solve the high interest rate spreads in the banking sector but will lead to other challenges such as locking out of SMEs and other “high risk” borrowers from accessing credit as banks will prefer to loan to the government.
This will strain the small banks which have been shut out from the interbank market and now have to mobilise funds at rates higher than what they are getting now and can only lend out within the stipulated margins. This has a huge effect on financial inclusion, when it comes to credit.
Therefore notion that with a lower interest rate, more Kenyans will access more loans is entirely misguided.
The interest caps will also cause a surge of creditors who will pass a vote of no confidence to the commercial lenders and instead seek out credit from informal financiers such as shylocks and chamas who may have their own set of margins that might not cater for the interest of the creditor. If anything, they will be vulnerable to extortion and raw deals in as far as servicing those loans are concerned.
The government of Kenya should seek out other initiatives such as setting up financial consumer protection regulations and enabling an innovative ecosystem of financial service providers, to serve as effective alternatives to interest rate ceilings. These measures can help prevent unhealthy lending practices while ensuring the development of healthy credit markets for low-income customers.
Insufficient information between financial service providers and their clients is a reality, it should be noted that commendable efforts are being made by financial institutions for the provision of financial products in a transparent and affordable manner. Along with the efforts towards more transparency, the downward trend of microfinance interest rates worldwide provides another argument against interest rate ceilings. There is no evidence on how an interest rate cap contributes to protecting low-income consumers, therefore Kenya should not be too hasty to adopt the caps, just yet.
The fact that the Treasury Cabinet Secretary, Henry Rotich and the Central Bank of Kenya Governor Patrick Njoroge are against the proposed Bill should help President Kenyatta make a sensible decision, not to assent to the bill, even as he consults widely with experts from the banking sector and government. Though he pledged to lower interest rates during his campaigns in the run up to the 2013 General Elections, he should remember that while he served as Finance Minister in the previous government, he shot down a proposal of the same interest caps in 2012.
He should draw inspiration from the economic situation that Zambia is facing currently partly as a result of the failure of interest caps in the nation. The fact is that there is a lot that the Government and key stakeholders needs to do to make our financial ecosystem more transparent and financially inclusive. Interest caps however, will not make all this a reality. Therefore, it is a no brainer that the nation is and will be better off without the interest caps.