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.
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:
The bill before the President of Kenya which seeks to:
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.
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.
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:
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.