By - Kiraithe Daniel Mutemi
Capping rates involves putting a ceiling to what lenders cannot be allowed to exceed in charging interest to borrowers of money. Although the interest rates fluctuates, most of the times, lenders charge the maximum they are granted by the interest rate cap law. A specified benchmark and spread above it means fluctuations when the reference such as London Inter-Bank Offered Rate (LIBOR) changes. Banking regulators set these benchmarks. In Kenya, it is called the Central Bank Rate (CBR). Kenya has walked the path of interest rate capping, and Central Bank of Kenya (CBK) is finding it difficult for the most prominent East African economy.
The banking industry was established in Kenya in 1906, 57 years before independence. The industry flourished relative to its peers in the region and in Africa in general. Majority of banks were foreign-owned and managed. After independence, government employees and other private sector workers were using formal banks to draw salaries and could get some credit, but people feared them because of the ‘colonial’ faces they carried. The banks in Kenya operated normally and made reasonable profits for 30 years. There were prospects of growth though, the majority of Kenya were un-banked. However, in 1993, things drastically changed.
Kenyan banks started making abnormal profits, a situation that was construed to be a misuse of their privileges to unfairly do business and extort customers. Lamentations went on for seven years until a sitting member of parliament Joe Donde sought to address it by way of legislation. Joe Donde bill of 2000 did not see the light of the day because the Kenya Bankers Association – KBA (the umbrella body of Kenyan banks) frustrated his efforts through a court process. KBA was opposed to the bill as it aimed to put a ceiling at the interest rate at which they would lend to borrowers, cutting down on the banks’ profit earnings.
The banks argued Kenya was a free economy that was self-regulating and thus did not require punitive measures such as interest rate capping to regulate. Kenya’s interest rates spreads were the highest among her peers for an extended period. The abnormal profits reaped by banks were a result of these high spreads.
By 2016, the cost of credit in Kenya was bloated to reach as high as close to 30% p.a! Most banks charged an average of 22% per annum, but new and risky borrowers would pay the highest rates. An outcry by the public to have the banks tamed to allow them access credit saw the enactment of the interest rate capping in Kenyan parliament the same year. On 14th September 2016, the bill became a law. They set a cap of 4 percentage points above the CBR. Things changed again.
Kenyans were hopeful they would access low-cost credit and spur entrepreneurship at the time when unemployment was hitting the country hard. General elections were fast approaching in the following year, and this brought some levels of confidence by locals on the economy and the political goodwill to grow the economy. CBK cautioned the implementation of the law even before the bill was signed into by President Uhuru Kenyatta in 2016. Through the regulators’ governor Dr. Patrick Njoroge, CBK argued The Banking (Amendment) Act 2016 would reduce competition, result in reduced intermediation among other undesirable outcomes in the economy.
Globally, other countries have walked the same path as Kenya in capping interest rates at different times. The United States of America, France, and Germany are in the list of the big economies that have, at one point, adopted some capping forms. In Africa, Zambia and South Africa introduced such measures to mitigate low credit access by small borrowers just like the case of Kenya.
Close to three years later, a review of the impact of the law on the Kenyan economy by different sources seems to converge views that it is not doing good to the economy contrary to the expectations of the majority during enactment.
Demand for credit
The need for credit increased although temporarily before customers started to shift to alternative sources of credit citing frustrations from the banks. Kenya private sector alliance (KPSA), the association of private sector players in the country carried out a survey to understand the implications of the law. The banking industry reported reduced lending by 83 percent of the participants. There were, however, few cases in tier 1 lenders where respondents said they experienced increased lending, but it was attributed to government and corporate borrowing as opposed to personal loans.
Similarly, CBK Credit Officer Surveys conducted after the enactment of the law revealed lenders increased standards for credit approvals from the last quarter of 2016. Credit demand increased in the last quarter of 2016, but a significant drop of the same was witnessed in the year 2017 due to the strict approval terms that discouraged borrowers from using formal bank loan procedures. This situation paved the way for the growth of unregulated mobile lending platforms.
With an increase in loan size by 36 percent in 9 months from October 2017 and a decrease in loan account in the same period, a reflection of lower access to small borrowers and disbursement of considerable amounts to the government and big corporations. The customer appraisal in Kenya has become punitive since the law took effect. It has become difficult for Small and Medium Enterprises (SMEs) as well as individuals to access credit as lenders cite high risk and low returns that do not correspond hence opting to lend to less risky sectors such as government lending. The results are consistent with what happened to South African, Ecuador, and Zambia when they implemented similar laws.
Alternative borrowing channels
Mobile loans thrived after the customers started finding it difficult to get credits through banking halls. Numerous lenders (banking and non-banking) emerged to fill the gap. The banks realized that they were losing and opened mobile banking channels to tap into the market. But customers have paid dearly for the short term loans that are usually unsecured, attracting more demand from credit seekers.
These loan apps are unregulated and therefore, do not adhere to the interest capping law terms. Some charge as much as 10 percent per month translating to over 100 percent interest rate per annum. This cost is against Central Bank Rate (CBR) of between 9 and 10 for the period the law has been in force, allowing banks to lend at between 13 and 14 percent p.a.
Competition and transparency
Primarily, competition in the banking industry is measured by the share of deposits and loans as well as weighted market share. Although the last three months of 2016 witnessed reduced competition, competition among banks has been relatively stable except for the small banks that lost significant deposits from the reaction of the peers in a re-engineering move. Some banks witnessed the introduction of hidden fees in an attempt to earn more as interest-earning was restricted. SME loan appraisal fees also increased significantly.
Kenyan banks have remained relatively profitable despite the interest rate capping, but it has generally declined in absolute terms. Majority of them are focusing on non-interest and fees income as opposed to interest from lending. Equally, banks have exploited the maximum 4 percent points above the CBR. Similarly, return on assets (ROA) and return on equity (ROE) for the banks have also been declining since the law came into effect.
Results from Kenya bankers association and the regulator CBK indicate there has been a sharp increase in non-performing loans mainly from tier II banks. NPLs ratio to total capital amongst tier II banks deteriorated to 69 percent in June 2017 relative to 19 percent a year before. What causes the high default rate despite the thorough appraisal and approval of loan process? Mobile lenders in Kenya issuing unsecured loans reports repayment rate far much better than banks.
With fingers pointing at the interest rate cap law regarding reduced credit access in the private sector, the contraction of GDP is subsequently attributed to it. According to CBK, 2016, witnessed a real GDP contraction of 0.22 percent while 2017 missed economic growth target. All these undesired outcomes in the economy blame interest rate cap law.
Although borrowers have seen the move by the banks to tighten borrowing standards as a way of arm-twisting the government to reverse its stand and repeal the law, others have argued it is the only way banks can protect shareholders investments from loan defaulters. There is a court case challenging the law. As many other counties walked the path of the interest rate capping and took different turns, Kenya is walking the unknown journey end in the same path. What will happen if it is repealed today as bankers and their regulator advocate? Well, we are still waiting to see.
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