Too Early to Abolish the Interest Capping Law – Expert

The famous banking amendment bill was passed by the parliament in July 2016 and became law September of the same year.  The law capped the lender’s rates by commercial banks at 4pc above central bank rate and minimum deposit at 70pc of CBR.

The law was expected to lower the cost of borrowing and increase access to credit upon implementation. Sadly, the implementation has faced many hiccups, some deliberate from key players and stakeholders in the industry and thereafter, giving unfounded reasons so as to have the law scrapped.

Kenya is a liberal economy. However, the previous (before the interest rate cap law) spreads between deposit and lending rates were very wide. In fact, Kenya’s borrowing rates were among the highest in the world. For a long time banks made super huge profits while borrowers especially SMEs suffered from the high cost of loans, this was ethically wrong and cannot be defended.

Informal Borrowing

According to the Economic survey, 2017 71.9 percent of licensed small and medium enterprises (SMEs) and 80.6 of unlicensed SMEs reported family and self-funds as the main source of startup capital. Further, loans from friends and family accounted for 4 percent of both licensed and unlicensed SMEs. Banks only financed 5.2 percent.

Therefore, banks financed a very small number of the micro, small and medium enterprises (MSMEs), which is the largest sector of the economy as it contributes to almost half of the country’s GDP. In fact, according to Economic Survey 2017 SMEs constitute 98 percent of all business in Kenya, create 30 percent of jobs annually and contribute 46.9 percent of the total GDP.

The high demands for credit by commercial banks such as collateral, credit selection criteria and the high cost of credit are the main reason why most SMEs rely on informal borrowing.

Banks have tightened their lending criteria since the inception of the interest cap law as they are not able to compensate for default risk of each borrower. As expected, the low cost of credit as a result of interest rate capping has increased the number of credit requests. Sadly, despite the high number of credit requests the number of loans to the SMEs did not increase.

For that, the interest cap law as expected has lowered the cost of credit, however, access to credit remains a challenge causing the SMEs to rely more on informal borrowing.

Too Early

While it is close to two years since the interest rate cap law became functional, it is still early to accurately determine its effects on each sector of the economy.

The law came into place when the country was heading to the 2017 general election. The elections fever in Kenya and the extended electioneer period had adverse effects on many businesses. In fact, many businesses reported a decline in profits or losses and worse some had to close down. Therefore, it is hard to solely attribute the poor credit uptake to the interest cap law alone.

Banks tightening of lending criteria may have had adverse effects on SMEs. However large corporations and government credit from local commercial banks may have increased.

The concerns of the opponents of the interest law capping should not be ignored. Continuous evaluation of the effect of interest law capping on different sectors of the economy should be done. However, the scrapping of the law should not be done before attaining the law’s initial objectives.  Other regulatory mechanisms should be put in place first.

What is your take on the interest rate cap? Fanaka TV will be holding an Interest Rate Debate at Strathmore School of Business on Monday evening. Join the discussion and give your views.

(This story has been written by Ruthline Wairimu, an Economist, Tax Expert and an Accountant)