To cap or not to cap interest rates? That’s the million-dollar question whose answer depends on where you sit during working hours.
Bankers, including the Central Bank of Kenya, for obvious reasons, want the law regulating interest rates repealed. On the other hand, borrowers who include businesses as well as consumer lobbies feel a return to a free market model in the pricing of loans will be punitive.
Clearly, the debate on interest rates has become very emotive, and inadvertently betrayed the capitalistic interests behind the renewed push to give banks a free hand in determining the cost of credit. This is being amplified by no lesser a personality than Central Bank Governor Dr Patrick Njoroge, as the controlled interest regime marks one year since coming into force.
Dr Njoroge, the surprising new champion of the repeal of the interest rates capping movement, says the law has had a negative effect on the economy. “I think it is clear to us that this has been problematic in many ways,” he said without giving hard evidence on the impact. “What I cannot tell you is the path going forward and how this will happen.”
Dr Njoroge said preliminary findings of a joint study with the Treasury on the impact of the rates capping on growth of credit had confirmed a negative impact on economic growth, as banks starved businesses and individuals of credit. But independent observers see behind-the-scenes interests at play.
Analysts argue that given that this law has only been in effect for a year, it is unlikely that sufficient data exists to support a credible study about its impact on the economy. “In the past year, there have been many activities in our economy that makes it difficult to zero in on the impact of this law,” argues Luther Odhiambo, a lecturer at the University of Nairobi.
This lends credence to the school of thought that the repeal is a response to commercial banks’ reluctance to extend credit to perceived high-risk borrowers who include consumers, small and micro enterprises. This, in fact, is the strategy that banks took after the law was signed by President Kenyatta in September last year. With CBK now on their side, banks appear to have managed to arm-twist policymakers’ minds that a controlled-interest regime is bad for the economy.
Industry lobby, the Kenya Bankers Association (KBA), in March this year warned that banks would divert more funds to treasury bills and other more lucrative opportunities in the forex market rather than lend to small borrowers, as they consider government debt less risky and more profitable. “The solution is to remove the law and consider some of the proposals that had been put forward by banks (prior to the new law) to address the issue of costly credit,” KBA chief executive officer Habil Olaka said.
The commercial banks say their research indicated that the rate cap was harmful to the economy. “According to the consumer research we have commissioned, most bank customers are not necessarily borrowing or saving more because of the Act, which raises the question, is this Act helping or harming our economy?” posed Mr Olaka.
The man behind the law, Kiambu Town legislator Jude Njomo, accuses banks of “blackmail” and “economic sabotage to force amendments to the law. He says banks had formed cartels to cut off credit to the public in an effort to “blackmail Parliament or the Government into changing a law that protects Wanjiku.”
Most banks have recorded a decline in earnings, and by extension dividends, with virtually all of them blaming the new law that limits interest rates on loans at 4 percentage points above the Central Bank Rate (CBR). But analysts say while the law could be hurting banks’ revenues, there are other more adverse dynamics in the market that have cost banks money.
“It is the capitalists in Parliament who decided to cap interest rates,” says Mr Odhiambo, “The same capitalists own banks, and now it appears they have realised that the political gain associated with capping the interest rate is less than the loss in their wealth.”
He added: “The owners of capital in Parliament forgot that by capping the rate, they were exposing themselves to losses. When Parliament legislated on interest rate, MPs thought it could reconcile the interest of lenders and borrowers through legislation. Parliament forgot that reconciliation could only be done through market forces, specifically the demand and supply for money.”
The Banking (Amendment) Act, 2016, which came into force on September 14 last year, caps loan charges at four percentage points above the Central Bank Rate (CBR), which currently stands at 10%, and requires lenders to pay interest of at least 70% of the CBR on term deposits.
Commercial Bank of Africa, for instance, (which is associated with President Uhuru Kenyatta’s family) lowered its interest rates to 12.9%, which is among the lowest in the industry. Although it is among the few banks that defied the law to record increase in profitability in 2016 – Sh2.7 billion from Sh2.3 billion a year earlier – it had to heavily cut expenses and increase non-interest incomes to turn in a decent profit. That’s the pain banks are not willing to undergo, and high-level lobbying appears to be bearing fruit with even the President softening his stance on a law that he signed himself enthusiastically.
Barclays Bank of Kenya chief executive Jeremy Awori takes a more cautious view. “This is a process because it has to go back to Parliament for action. What I can say is that the banking industry is keen not to return to the days when we had runaway interest rates,” he said. “I don’t think this is healthy for anybody. We really need to try and keep interest rates as affordable as possible.”
CBK Governor Patrick Njoroge, however, says he has a formula to manage interest rates under a free-style regime. He says Kenyan commercial banks will have to be more disciplined in the pricing of loans. But as history shows that unwritten agreement has often been ignored by all the banks. During the past regimes, especially so under Dr Njoroge’s predecessor Prof Njuguna Ndung’u, banks would defy all policy signals and price loans at as high as 24% interest.
Even a ‘naming and shaming’ tactic of publishing the interest rates each bank charges to expose the most expensive ones did not achieve much as it would be countered psychologically by banks, which would immediately announce marginal drops in interest of fewer percentage points.
“What needs to change is the discipline among lending institutions,” Dr Njoroge says. “They cannot go ahead setting interest rates the way they were doing before. And it is our job to deal with them in the context of that market discipline.” The market can only wait and see if Dr Njoroge really means his words.
Mr Odhiambo says allowing financial institutions to charge whatever interest rates they want could harm loan consumers, and ultimately undermine economic growth. A more realistic model would involve creating an environment where risk, demand and supply drive interest rates, he said.
“Solving the interest rate problems requires additional approaches. CBK as an advisor to the government must advise the State to go slow on its borrowing. As long as demand for money is high, the interest rate will remain high. As long as the Treasury bill rate is high other interest rates will be higher,” he said.
Growth in credit to the private sector slowed to 2.1% in May compared to over 17% in December 2015, CBK data showed in July. This could be attributed more to the political situation in the country, which has slowed business since the second quarter of 2017, and with it uptake of credit. It is expected that credit will remain depressed as the country goes into a repeat presidential election that has virtually brought the mainstream economy to a snail’s pace.
Since the law came into action, banks have been adjusting to survive the new environment. Some are increasingly moving away from the brick and mortar branches model. Many are actually now closing some branches, favouring technology-supported services like mobile, Internet and agency banking.
Early July, Standard Chartered Bank Kenya announced the closure of four branches by the end of August as it digitised its processes. Bank of Africa Kenya (BOA) also announced in January that it was shutting 12 branches to remain with 30 branches and Ecobank, too, closed a number of branches two months ago. Barclays Bank of Kenya (BBK) in September closed seven branches across the country in a move to save cost.
Meanwhile, at least nine banks have announced job cuts to protect profits. KCB is cutting about 500 jobs to save at least Sh2 billion annually while BBK is expected to cut at least 130 jobs. Bank of Africa, National Bank of Kenya, Sidian Bank, Family Bank, First Community Bank, Standard Chartered Bank and Ecobank have also announced unspecified staff cuts. Data from CBK shows that alternative service channels pushed out a record 2,517 workers from the banking halls in 2016 alone.
Analysts say this is the efficiency that’s needed for banks to cut costs and grow their revenues, rather than relying on interest from highly priced loans which, often times, would result in high defaults and even higher non-performing loans provisioning. This has forced banks to look for less risky clients to lend to, ending up with more credit going to the government.
Treasury bills and bonds have come to their rescue as many shy off from customers whose risk is above the ceiling that CBK has set. “We are moving away from volume lending to quality loans. In times of crisis, cash is the king,” says Equity Bank CEO Dr James Mwangi whose bank recently announced that it will be slowing down on unsecured loans.
To keep the credit pipeline flowing, banks should help reduce the level of risk associated with this segment instead of blacklisting micro, small and medium enterprises (MSMEs) and SMEs. Analysts say they should launch SME-centred products instead of labeling them as risky and untouchable. Lenders can de-risk the SMEs through capacity building on good book keeping practices, financial management and ethical practices to help such humble businesses grow.
In all the noises, Mr Njomo has backing from a very likely quarter. Consumers Federation of Kenya (COFEK) says the plan to lift the rate cap on loans, has “no basis”. “COFEK will do everything possible to keep the rate caps until such a time CBK and National Treasury will address the non-transparent pricing of loans and reduction of the cost of credit in Kenya,” says COFEK Secretary General Stephen Mutoro.
Removing caps, it is argued, would endear catalyze banks to lend to government whenever the rate being paid by the state is higher than that paid by businesses. “The cost of doing business is too high due to corruption,” said Odhiambo of the University of Nairobi. “For example, if a projects input cost Sh100 million, but you have to pay a bribe of Sh10 million to get the contract, you end up borrowing Sh110 million and not the required Sh100 million. The interest you pay will be on Sh110 million, yet Sh10 million inside the Sh110 million is not invested in the project.
A free market arrangement compounded by corruption can result in borrowers failing to service their loans. As such, banks must look at their operating costs to improve on their earnings and survival, which would allow them to reduce the cost of credit.
“Closing branches might not be the solution. Control of cartels is the solution,” says Odhiambo. “Additionally, banks must avoid price wars that force some of them to price their products below the product cost. They should make their money from two ends, the revenue and cost ends. Crime and fraud risk are real risks that banks must manage.”
There is also concern that removing the cap on interest rates could hit and inconvenience existing borrowers who took up loans on lower rates. Banks are likely to revise their terms to reflect the new free-market loan pricing, which will raise interest on existing loans. “CBK must ensure that those who borrowed money when the interest rate was capped are protected – otherwise many of them will be pushed out of business,” say Odhiambo.