On 24th August, 2016, his Excellency the President Uhuru Kenyatta assented to the Banking (Amendment) Bill, 2015 to great public acclaim. The new law has introduced limits on interests that banks can charge on loans and deposits. This was not the first time Kenyan legislators have attempted to cap the lending rates; previous attempts failed, partly due to intense lobbying by the sector.
The Banking (Amendment) Act, 2015 (the Act) amended the existing Banking Act by inserting a new section 33B which caps the lending rates for all banking institutions at four percent (4%) above the base interest rates set by the Central Bank of Kenya (CBK). The Act has also set the minimum interest rate on deposits at seventy percent (70%) of the base rate set by the CBK.
Banks which contravene the provisions of this law shall have committed an offence punishable by a fine of not less than K.shs.1,000,000.00, or imprisonment for a term of not less than one year, or both. Imprisonment shall presumably apply to directors and other principal officers. It is worth noting that the law only prescribes minimum penalties, with the courts having discretion on the upper limits of the same, and observers may note that Kenyan courts have historically been viewed as sympathetic to borrowers.
It is a well-established legal principle that laws should not apply retrospectively. On this basis, some quarters have interpreted that the capping of interest rates should not apply to loans and deposits made before the law was signed. However, since the Act makes a blanket unqualified statement that the contravention of this provision constitutes an offence, other quarters have posited that banks which charge interest outside the rates set by the new law on preexisting facilities shall be committing an offence. In any event refusal by banks to apply the new law to old facilities would be self-defeating, since a borrower has the option to move their facility to the next bank where it will qualify for the capped rates, as a new facility.
Strict regulation of interest rates is not usually the first line of action in achieving market equilibrium for the banking sector. The sector has its unique set of risks and variables. In United States, United Kingdom and the European Union, banks regulate themselves, charging an average of less than three percent (3%) above the base interest rates set by the respective bodies in the jurisdictions. However since there has not been much demonstrated capacity by banks in Kenya to self-regulate, capping the rates was perhaps a measure of last resort.
With the new law in place, it is likely that banks will register reduced profits if the reduced interest rates will not be accompanied by a proportional increase in borrowing, especially if banks react by adopting selective lending criteria to exclude small and medium enterprise borrowers, as predicted by some observers. Banks could also attempt to circumvent the rate ceiling by introducing steep service and operational charges to compensate for loss of profits. Some small banks are also likely to exit the market due to reduced dominance in the processing of microcredit if borrowers resort to bigger institutions which, due to larger economies of scale, will be better able to absorb the fiscal consequences of the new law. In the immediate horizon, this may lead to a destabilization in the financial sector since the liquidity levels of the small banks may be adversely affected, leading either to consolidation of small banks or the exit of others from the market, leaving the most stable and liquid banks to dominate the scene.
How this plays out in the long run will largely depend on the CBK’s treatment of base rates.
Please contact us at Info@cfllegal.com should you require further information.
