President Uhuru Kenyatta’s assent to the Banking (Amendment) Act, 2016 has been termed one of his more controversial legacies. The law introducing caps on interest rates for lending and deposits, which came into effect in September, 2016, was passed in recognition that banking culture in Kenya has for a long time, incubated predatory pricing. Six months later, the effect of this enactment has been far reaching and in some cases, unintended.
The Law of Unintended Consequences
Restrictive Credit Profiling: Households, the private sector and small banks have been named the unwitting victims of the silent war between banks and the government over the capping of interest rates. Many banks have unofficially scrapped unsecured loans and household loans, which are now classified as high risk. As a result the average person and business now finds qualifying for a loan at mainstream banks very challenging.
Economic Sabotage? Having excluded a substantial chunk of the borrowing market by denying credit to household and private borrowers, banks are opting to invest in the relatively risk free Treasury Bills to maximize returns. According to the Kenya Bankers Association (KBA), as long as the return on Treasury Bills continues to outweigh other higher risk initiatives, banks will definitely prefer government securities. KBA adds that this can be expected to last until the rates come to within what is “expected”, terming the interest cap as distortionary. The legislator behind the rates capping law, however, says banks are causing an artificial credit crunch in order to frustrate Parliament whose intention was to entrench fair banking practices for public good, adding further that if banks are deliberately sabotaging the financial sector, the Central Bank of Kenya (CBK) should take punitive measures against such banks per its mandate.
The Rise of the Shylock: Not surprisingly, the primary beneficiaries of the law have been shylocks and micro-lending institutions to whom the rate cap does not apply, since they present an alternative source of credit for frustrated borrowers who cannot access bank loans, albeit at inhibitively steep cost.
Bad Debt: Another interesting outcome of the cap is the spike in bad loans. Smaller unsecured borrowers are taking advantage of the law by defaulting on loans, secure in the knowledge that they may only face token consequences for default, if at all, since the rate cap regime precludes the charging penalty interest rates for default.
Bank Devaluations and Restructuring: The minimum rate on deposits has certainly accelerated the decline of smaller banks and ensured that large banks become near-invincible by making it almost impossible for the former to mobilize deposits. The cap is also making its effect felt in bank deals, with more banks now being acquired at prices lower than their book value. According to an article titled ‘Interest Rate Caps Erode Bank Valuations in Buyouts’ featured on the Daily Nation, 23rd March, 2017, share prices of most listed banks have also dropped more than 30% in a year due, partly, to the rate cap, with some of the publicly traded banks trading below their net asset values. The article notes that the current valuations mark a sharp reversal from previous years when acquirers were ready to pay up to two times book value or higher in private transactions and on the stock market.
Declining Tax Revenues: The Kenya Revenue Authority has also reportedly experienced a shortfall in revenue targets.
The Future
An article titled ‘This Is What Review of the Law Capping Rates Needs to Address’ appearing on the Business Daily, 3rd March, 2017 suggests that the law needs to be given a chance in order to “peel off the rent-seeking coats of banks and instead entrench their core utility function”. The author suggests the three adjustments to the interest capping law. First, that the pricing cap should only be applied to secured products, and to rationalize this, CBK should provide more guidelines on what qualifies as secured lending. Secondly, the blanket application of the interest cap on deposits would need to be scrapped and its applicability expressly restricted to savings accounts and pegged on a minimum amount that makes commercial sense e.g. on amounts exceeding K.shs. 10,000.00. Finally the author questions the use of the CBK Rate as the applicable base rate for purposes of the interest cap and reiterates that a separate base rate needs to apply.
Another view suggests banks need to find ways to balance development of their portfolios and conduct objective risk assessment rather than subjective profiling and exclusion of an entire class of borrowers. Studies show that banks can substantially reduce default rates by fully integrating credit reference bureau data.
With Kenya continuing to be a global innovation hub for mobile financial services, banks can also cast their sights on diversification of products using innovative mobile financial services to help improve their returns and thus combat the effects of the interest cap on their earnings.
Conclusion
In a capitalist economy, free market policies are often preferred and encouraged because in most cases the merits outweigh the demerits. It is not in dispute that capping interest rates has disrupted free markets in the Kenyan financial sector, but this may be justified as a necessary evil. In the free market era that preceded the rate caps, banks charged high interest rates almost indiscriminately. However critiques point out that lawmakers’ attempt at controlling interest rate as a single factor in the financial markets while leaving everything else free was not very sound economics.
While the signs are not positive, observers note that six months may not be sufficient to make a conclusive judgment as to whether the law has achieved its goals. The interest cap has not been a solitary contributor to the current state of affairs. Over the past year or so, the Kenyan financial sector has been shaken by other additional factors including the tightening of the regulatory controls and an overall bleak economic outlook (such as impact of the drought on prices, inflation etc.) The Treasury principal secretary has noted that the decline of credit growth to the private sector and households started long before the rate capping law passed through Parliament, and that prior to September, 2016 private and mid-sized enterprise lending had already slowed down.
The exact nature of the impact of this law has had on the financial markets would have to be empirically analyzed by the regulator. It is not expected that the government will make premature steps to reverse the rate capping law during an election year, which allows the CBK sufficient time to study the market and propose viable adjustments for the long term. This may be why despite hints by the CBK Governor that the law may be disabling the efficacy of policy signalization, the CBK monetary policy committee, (MPC) voted to retain its policy rate at 10% for the meantime.
In conclusion, it has been stated that all stakeholders must recognize that any effort to correct the distortions in the financial markets must be premised on the mutual acknowledgement that a mere return to the regime of astronomically high interest rates will not suffice.
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