Interest Rates Cap Is Kenya’s Brexit, Popular But Unwise -#CytonnReport

By Juma / Published August 22, 2016 | 7:10 am

This week’s focus note is about the ongoing debate on interest rate caps. The Kenyan public is lately very angry with Kenyan banks for a whole list of reasons – we have had recent bank failures but there isn’t a single ongoing prosecution, livelihoods and investment deposits lost or locked up in failed banks, investments lost in bank bonds such as Chase and Imperial Bank bonds, value of investments in bank shares have almost been halved, and yet banks continue to charge high interest rates on loans coupled with low interest rates paid on deposits.

Trust for the Kenyan banking sector is at its most recent low. The anger has culminated in the Kenyan people delivering an interest rate cap bill that has broad base support and is now only awaiting presidential signing to become law. We compare the interest rate cap bill to Brexit – a very populist move, fueled by anger, but an equally unwise move that we may quickly regret.

Read: Capping of Interest Rates To Hurt Small Banks

Our view is that interest rate caps would have a clear negative effect on the Kenyan economy and ultimately to the Kenyan people. Consequently, the President should certainly demonstrate leadership by declining to sign the bill into law because it would not be good for the Kenyan public. However, the President should also understand the bill as a strong protest by an angry public, and in return deliver to the Kenyan people:

A strong consumer protection agency and framework,
Promote initiatives for competing and alternative products and channels that will make the banking sector more competitive.

The bill before the President of Kenya which seeks to:

Cap interest rates charged to borrowers to 4% above the Central Bank Rate (CBR),
Set a floor for deposit rates paid to depositors at 70% of the CBR, is a bad bill and we are confident the president will not sign the bill, simply because it would have a negative impact in the financial sector and ultimately the economy.

With CBR currently at 10.5%, the bill seeks to limit lending rates to 14.5% (CBR benchmark of 10.5% plus 4% margin cap) and enforce interest on deposits to 7.35% (70% of CBR benchmark of 10.5%). While the prospects of getting loans at 14.5% and receiving 7.35% on deposits seems attractive, a closer analysis reveals that in reality, rate caps would have significant negative effects such as reduce access to funding, slow the economic growth and ultimately reduce the standards of living.

First, general observations of global trends:

A general survey around the world illustrates that free movement and pricing of labor, capital, goods and services, otherwise referred to as free markets, tends to be strongly correlated with stronger economic growth and prosperity. This does not mean that there should be absolutely no government involvement, but that government involvement should be very constrained, limited and targeted for example, requiring specific disclosures. Legislating the price and terms at which private citizens access capital is wading too far into the private sector. Kenya’s own recent track record with government involvement in the private sector is not inspiring; think of Uchumi, National Bank, Mumias Sugar, and Kenya Airways – all these companies are suffering in industries where other pure private sector competitors are thriving. Governments are not good in private sector matters such as pricing of capital.

Secondly, there is just no compelling evidence that interest caps have worked.

According to a World Bank report, there are 76 nations in the world that have experimented with interest rate caps. Based on a reviews of their experience, The World Bank report concludes that rate caps are blunt instruments, and supports other alternative interventions, and in many cases, there is clear evidence of negative effects. Here is a sample of experience with rate caps according to the report:

While rate caps are bad, it does not mean that the government should do nothing. President should send back the bill to parliament with specific recommendations around consumer protection and improved competition:

Establish strong consumer protection agency to specifically develop and enforce a consumer protection framework for the financial services sector. Just like the bankers have the Kenya Bankers Association taking care of the interest of banks, there should be an equivalent and strong association / agency taking care of the interest of consumers. It should be a strong association anchored in law and funded by statutory levies from the banking sector players and other financial services companies
The aforementioned consumer protection agency would work on a consumer protection framework to include robust disclosures on cost of credit, free and accessible consumer education, enforce disclosures on borrowings and interest rates, expeditiously handle and hear clients’ complaints. The rumors of an office of an Ombudsman with the powers of a judge seems to be headed the right direction
Establish strong protection and support for alternative products that compete with banking products. For example, the proposed legislation is not just concerned with rates of borrowing, but also the meager rates banks pay to depositors. Alternative forms of savings that bypass the banking sector to enable members earn higher levels of returns, such as organized Chamaas, Saccos, Investments Cooperative and Partnerships should enjoy the same incentives such as banks. For example, providing alternative savings organizations with the same withholding tax incentives that banking deposits enjoy, of a 15% final withholding tax

In addition to supporting alternative products, the government should develop incentives and protections for product innovation, which tend to experience hostility from the banking sector.

Read the full Cytonn Report here.

About Juma

Juma is an enthusiastic journalist who believes that journalism has power to change the world either negatively or positively depending on how one uses it.(020) 528 0222 or Email: info@sokodirectory.com

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