Capping of Interest Rate done more bad than good on the economy – Analysts

With the capping of interest rates at 4 percent above the Central Bank Rate (CBR)  came an opportunity for banks to innovate and protect their income streams.

However, global financial institutions, World Bank, the IMF and Analysts fault the move.

The latest entry is Cytonn Investments who in their weekly brief state that, “The Banking (Amendment) Act 2015 has done more bad than good on the economy thus far, and if the situation is not arrested, could impact negatively on the economy.”

Besides Kenya being ranked as the fifteenth most attractive economy for investments flowing into the African continent, according to the latest Africa Investment Index 2016 by Quantum Global’s independent research arm, Quantum Global Research Lab, Prof Mthuli Ncube, Head of Quantum Global Research Lab states, “Supported by a stable macroeconomic environment, Kenya presents investors with relatively high exchange rate risk, low levels of liquidity and very low import cover.”

“However, going forward, the government policy of capping domestic interest rates is limiting growth on domestic credit to the private sector. This has the potential of being a drag on future economic growth, in an otherwise dynamic economy,” He adds.

Financial Times reported that the challenge, however, is with monetary and financial policy. Companies across the economy are suffering from the repercussions of a government-imposed cap on commercial interest rates.

The latest data from the Central Bank (CBK) indicates that private sector credit growth slowed to 4.3 percent for the 17th consecutive month in December 2016, and subsequently to 4.0 percent at the beginning of 2017, way below the government set target of 18.3 percent.  

CBK attributes this to the slowdown in credit growth to structural factors in the banking sector, evidenced by increasing levels of non-performing loans and subsequent provisioning, as opposed to monetary policy decisions.  

“Commercial banks’ lending to Micro, Small and Medium Enterprises (MSMEs) fell by an estimated 5.7 percent between August 2016 and April 2017, but small banks recorded increased loans to the sector on aggregate,” notes CBK after its Monetary Policy Committee (MPC) meeting in May.

“The number of loan applications increased by 23.4 percent between August 2016 and April 2017, but the value of loan applications decreased by 18.3 percent, suggesting smaller size of loan applications. The number of loan approvals increased by 35.7 percent while their value decreased by 16.3 percent,” it adds.

According to CBK, the share of loans to corporates increased relative to small businesses and personal loans since the capping of interest rates, with the number of loan applications received by banks increasing between September and December 2016, and the average maturity of these loans shifting to the shorter term. However, loan approvals declined by 6.0 percent between December 2016 and February 2017.  

The fourth quarter of 2016 also saw a 4.7 percent decline in savings accounts following a 9.6 percent decline recorded in Q3’2016, which indicates the continued re-classification of savings accounts into checking accounts by commercial banks, following the capping of interest rates.

“3 banks, NIC Bank, Stanbic Bank and KCB Group have released Q1’2017 results, the effects of interest rate capping on the banking sector are becoming more apparent as the banks posted 3.9 percent, 9.3 percent and 1.9 percent declines in core earnings per share (EPS), with NII dropping by 8.4 percent, 12.4 percent and 4.7 percent, respectively,” Notes Cytonn Investments.

Out of the 11 listed Kenyan banks, that have released their Q1’2017 results, Cytonn says, “The sector has, however, experienced faster deposit growth and all banks showed efforts to protect their Net Interest Margins given that this was the quarter when the full effect of the law capping interest rate was in effect.”

Cytonn Investments note that Credit growth is now at 4.0 percent compared to 5.4 percent when enacted and way below the policy target of 18.3 percent because the bill, ‘has failed to live up to initial expectations of cheaper and more access to credit’ and the cost rationalization measures are primed to see continued lay-offs in a challenging operating environment.

Subsequently, data from the Kenya Bankers Association shows that private sector credit growth slowed down from 17 per cent at the start of last year to 4.3 per cent in December 2016.

Gerard Lyons, an economist based in London in the Financial Times writes that, “Although the central bank has identified correctly the need for a stronger banking sector with increased transparency, the challenge is that there could be a far better approach to achieving these goals and restoring confidence about the future than that being pursued.”

On the other hand, the Central Bank Governor Dr. Patrick Njoroge says the banking sector has stabilized and strengthened underpinned by three pillars: enhanced transparency, stronger corporate governance and better business models.

And on the interest cap, in the African Business, April Issue he states that, “We can’t say for sure how the interest cap will affect the banking sector, there is insufficient data available to us at the moment. What we can say for sure is that the average interest rates for the country have fallen.”

He adds that, “Of course the cap will have an impact on profits, but they can still thrive without charging extortionately high interest rates. We expect the cap will weaken bank’s balance sheets to a limited extent, but not dramatically.”

According to International Monetary Fund (IMF), sustained capping of commercial banks’ lending rates at 4 percentage points above the Central Bank of Kenya benchmark rate ‘if maintained, they could potentially pose a risk to financial stability,’ has warned.

“It is essential to remove these controls, while taking steps to prevent predatory lending and increase competition and transparency of the banking sector.”