Back to Expensive Loans as the Short-lived Interest Capping Law is Declared Unconstitutional

The ruling by a three-Judge High Court Bench in Nairobi declared the Banking (Amendment) Act 2016 to be unconstitutional signaling the comeback of expensive loans soon.

Enacted in 2016, the law stipulates a deposit and loan-pricing framework that provided for:

• A cap on lending rates at 4 percent above the Central Bank Rate (CBR)
• A floor on the deposit rates at 70.0 percent of the CBR, which was scrapped in October 2018.

Following the ruling, the cap on lending rates at 4.0 percent above the Central Bank Rate (CBR) will no longer be effective, after the 12-months implementation period.

Noting that the implementation of this rule would come with a lot of disruption to the Financial Services sector, the High Court suspended the effect of the declaration for 12-months, thus allowing Parliament time to reconsider sections that were declared unconstitutional by the High Court.

The ruling follows a series of calls to amend the Act with the most recent being a proposal that was tabled by Mr. Moses Kuria, the Member of Parliament for Gatundu South in January 2019.

The proposal made was to amend the Act to allow credit consumers negotiate for interest rates on loans, depending on their risk profile, with an upper limit of up to 6.0% above the existing interest rate cap levels.

This would have seen borrowers be able to access credit at rates of a maximum of 19.0 percent per annum compared to the current rate of 13.0 percent. The Central Bank of Kenya echoed this sentiment and lauded the members of parliament for acknowledging the negative effect of interest rate cap on the economy.

CBK Governor Dr. Patrick Njoroge has also maintained his stand that the law should be completely overhauled to encompass a system that allows banks to adopt a risk-based lending approach. These efforts have been in a bid to try and improve credit extension to the private sector, comprised largely of the Micro, Small and Medium Enterprises (MSMEs), as private sector credit growth averaged 3.3 percent in 2018, way below the 5-year average of 11.8 percent.

The suspension duration is expected to serve as a transition period to avoid disruption of current contractual agreements between banks and their customers and, on the other hand, allow parliament to assess and amend the provisions in contention.

Section in Contention 

Section 33b of the law on interest cap is what is in contention. Here is an excerpt from the same:

33B. (1) A bank or a financial institution shall set (a) the maximum interest rate chargeable for a credit facility in Kenya at no more than 4%, the base rate set and published by the Central Bank of Kenya.

(2) A person shall not enter into an agreement or arrangement to borrow or lend directly or indirectly at an interest rate in excess of that prescribed by law.

(3) A bank or financial institution which contravenes the provisions of subsection (2) commits an offense and shall, on conviction, be liable to a fine of not less than one million shillings, or in default, the Chief Executive Officer of the bank or financial institution shall be liable to imprisonment for a term not less than one year.

Blow To SME Sector

Proponents of the Interest Capping law thought fixing the interest rates would enable Kenyans, especially the Small Medium Enterprises (SME) have access to affordable loans. They were wrong.

Immediately the Bill was signed into law, commercial banks refrained from lending to individuals as well as SMEs. More than two million accounts were affected as a result. SMEs went into more trouble than before.