Banking Sector Reforms Vital for Growth
August 2016
It has been observed that the real interest rate spread in Kenya is among the highest in the world
despite the banking sector undergoing substantial liberalization.
The Banking Amendment Bill 2016 proposes to put a cap on the rate of interest charged for loans
and to fix the minimum rate of interest that such institutions must pay on deposits held. It also
seeks to set the maximum interest rate chargeable for a credit facility in Kenya at no more than
four per cent above the base rate set and published by the Central Bank of Kenya. In addition, the
Bill stipulates that the minimum interest granted on a deposit held in interest earning in Kenya to
at least seventy per cent, the base set and published by the Central Bank of Kenya.
The Bill further seeks to amend Section 33A of the Banking Act by introducing a new section
which provides for interest ceilings. The question worth consideration is the extent to which such
a regulation would have on the health of the financial sector and by extension the availability of
credit.
It is worth noting that since 1906, when banking operation started in Kenya until 1992 interest
rates were capped, that is 86 years of capping! In the same period of capping, banks still made
reasonable profits and most of them prospered. In the year 2000, Hon. Joe Donde tried again
through the Donde Bill to address the issue of interest rates but did not get much support from
stakeholders. Last year, there were fresh attempts to cap bank interest rates through the proposed
amendments to the Finance Bill 2015. However, this did not go through as well.
Capping of interest rates has been necessitated by the perception of a skewed credit pricing model
which has been employed by the banking sector. This gave rise to the public cry that the banking
institutions are making substantial profits to the detriment of borrowers. In consideration of
whether or not to support the proposals to introduce interest rate ceilings in Kenya, it’s imperative
to look at the factors for and against such policy initiative.
Whilst we appreciate the country’s steps towards full liberalization of key sectors including the
banking sector, an assessment of the impact of liberalization may be necessary. In the case of the
banking sector, we must state clearly that liberalization has indeed mid-wifed significant growth
within the sector. This notwithstanding, it would be a case burying our heads in the sand to assume
that liberalization is proceeding well in light of the credit financing challenges facing borrowers
in light of the prevailing high loan interest rate regime.
The Institute is of the considered opinion that the banking sector in Kenya has operated on an
oligopolistic market model where credit pricing does not reflect market fundamentals. Hence the
move to cap interest rates is welcome and should be implemented in public interest to yield benefits
to consumers from high rates by making loans affordable and increase access to finance. In
addition, interest rates ceilings should be used to support a specific sector of the economy where a
market failure exists or where there is need for more financial resources. Such market failures
often result from information asymmetries and the inability of financial institutions to differentiate
between risky and safe customers.
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Secondly, interest rate ceilings prevent naïve and ignorant borrowers from agreeing to loan terms
on which they will eventually default! Interest rate ceilings is a good way to limit access to credit
to some impaired and low-income consumers, because they help avoid social harm.
Lastly, it has been argued that prices charged for access to credit can be capricious and
anticompetitive; and therefore be higher than the true cost of lending, setting a lower cap on interest
would provide a conducive environment for lenders to operate.
On contrary, critics of the legislation argue that the reason for the high interest rates is not market
power but one of risk. In the argument, they maintain the position not to lend if it is unprofitable
a position that is business-wise. However, we interpret this position by the banking sector that
interest rates only make business-sense if they yield super-profits. We also take note of the second
opinion that interest rate caps inefficiently exclude some borrowers from getting credit. As such,
being denied credit not only has an instant effect on the borrower, it also affects his ability to build
a credit history, a critical support borrow at lower rates in future. It is also claimed that as a
consequence of being denied credit from legal lenders, borrowers sometimes resort to illegal loan
sharks or unscrupulous means of obtaining liquidity at higher costs of credit than an ordinary loan.
On the claim of perceived risk in relation to rate of default, we are of the opinion that it is unfair
for banks to brand all retail customers as being at the same risk profile and thereby punishing the
erstwhile good customers who have a lower risk profile alongside the bad borrowers. The role of
credit reference bureaus which banking sector as laid claim to is rarely utilized to determine the
risk profile of retail customers.
Many countries have embraced a similar regulatory framework for interest rates controls.
Argentina, France, Zambia, Canada, Germany, a host of countries within the European Union and
Africa that have successfully resorted to such measures in order to protect their citizenry from
exploitation. Contrary to the sentiments expressed against this policy reform, the banking sectors
of these countries are considerably more vibrant and efficient.
The justification for interest rate ceilings in the other countries is singly to protect consumers
against exploitation as it was demonstrated by the respective banking sector players. It was also
viewed as an intervention against financial segregation by preventing over-indebtedness in high
cost credit to shaky and unsafe debtors. This should speak to the case at hand. It may add value to
cite the normalcy within the oil sector that is attributed to monthly price controls that are prescribed
by the Energy Regulatory Commission against similar run-away pricing model employed by the
oil sector cartels.
The collapse of banking institutions in the recent past, saw the Central Bank recommend policy
reforms in the operating environment. Several licensed institutions, mainly commercial banks,
have had to merge or get acquired. Some of the reasons put forward for mergers and acquisitions
are: to meet the increased levels of minimum share capital requirements; expand distribution
network and market share; and to benefit from best global practices among others. Capping interest
rates and predetermined minimum in interest on deposits will further assist this reform agenda.
The policy reform proposed by the Banking Amendment Bill 2016 must be viewed against the
Government’s fiscal policy interventions. It is thus critical that the Government must deal with its
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growing appetite for debt raised from the domestic market and focus on negotiating cheaper loans
from the external markets to avoid crowding out the private sector out of the domestic market.
The Banking Amendment Bill proposals if well implemented, can be a good way to protecting
consumers from high interest rates and thus makes loans affordable and enhance economic growth,
a reform that the Institute is in support of. However, it is important that all key stakeholders are
engaged to arrive at an amicable framework to avoid a situation where the main banking sector
catapults to scamper the well intentioned legislative measures if they are not adequately consulted.
FCPA Fernandes Barasa,
Chairman, Institute of Certified Public Accountants of Kenya
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