Here Are The Effect of Kenyan Interest Rates in the year 2020

In a free market, interest rates reflect the price of risk. In the advent of the truly free economy in Kenya when the NARC government took the reins of power in 2003, the banking sector faced a revolution; a disruption triggered by hitherto small players in the banking sector.

The aftermath was an unprecedented uptake of formal banking by individuals and corporates. Some “small banks” signed up so many depositors, that the mainstream banks got into a panic mood. The sector was transformed for life.

The presence of so many bank account holders meant that a broader exposure to risk. Banks had to do business. Their profits jumped from millions to billions. With a bloated loan book also came a big portfolio of non-performing loans. This triggered an increase in interest rates over the years. By September 2016, interest rates on loans averaged 18 percent (Some banks were charging up to 26 percent in the previous few years).

In September 2016, the Banking (Amendment) Act 2015, which capped interest rates at 4 percent above the CBR for interest on loans and 4 percent below the CBR on deposits came into force. The CBR stood at 10 percent, which meant that the ceiling for interest on loans was 14 percent and the floor for interest on deposits was 6%. The government was trying to regulate the banking sector against market forces.

This amendment was celebrated by a sizable number of citizens who had or intended to take up personal loans. Even some business people celebrated it. However, some, including banks protested, and termed it populist. It was just a matter of time before many realized that they could not access these loans from banking institutions.

The players in the banking sector considered that the cap on loan interest was too low a price for the risk a loan to an individual or an SME carries. On the other hand, the government offers risk-free investment opportunities in the form of bonds, bills, and other securities. Banks thus opted to do business with government instead of individuals and SMEs. In September 2016 when the interest cap law came to force, government domestic borrowing was Kshs 1.17 trillion.

In September 2019, the government’s domestic borrowing almost tripled to Kshs 2.7 trillion in just three years. The increase of Kshs 1.6 trillion in a period the government was servicing big loans for infrastructure, and corruption was at its peak meant that a lot of this money did not get to circulation in Kenyan.

The country’s economy was deprived of credit, and only government was able to access it – which is used to service foreign loans and fund corruption – all these led to low liquidity, reduced business transactions, SMEs closing shop, increased unemployment, people not having purchasing power – in turn affecting multi-nationals, profit warnings by large corporations, laying off of staff across every sector, companies losing capitalization and many many other negative impacts.

In the run-up to September 2019, the effects of the interest rates on the economy had hit home and there was disquiet from many quarters. President Kenyatta considered this and send a memo to parliament to rescind the interest rate cap (with some conditions), which got passed.

The banks can now go back to pricing risk and issue loans to individuals and SMEs at risk-adjusted interest rates and do less business with the government. If they play, liquidity will likely improve. Business transactions will increase, SMEs will spring back, people will have higher purchasing power etcetera, and there will be ripple multiplicative effect in the economy which shall be felt by every sector and everyone. If they don’t play, government domestic debt will continue ballooning and the economy will continue accelerating southwards.

READ: Banks Will Now Have Their Way in Setting Interest Rates on Loans

This article has been written by Finance Consultant at Zenuha Augustine Matata.

Get in touch with Augustine via info@zenuha.com