End of Interest Rate Caps?

The recommendation by President Uhuru Kenyatta to repeal the interest rate cap could mark the abolishment of the current regulated loan-pricing framework. The main reason for the enactment of the Banking (Amendment) Act 2015 in September 2016 was to make loans more affordable and protect consumers from excessive interest rates.

Save for spurring alternative financial services channels, which could have long term positive effects, interest rate caps have a mostly negative effect on economies in which they are implemented. To begin with, it sidelined specific segments of the market from accessing loans in Zambia, Kenya and WAEMU countries. The most affected groups were small borrowers, MSMEs, rural clients, women and the youth. Similarly, it led to an increase in average loan sizes, reflecting lower access to small borrowers, and larger loans to more established firms. It also caused a proliferation of loan fees and commissions, making it more difficult to determine the cost of credit. Additionally, alternative credit providers such as Shylocks and unregulated lenders flooded the market, bringing with them predatory lending practices. Lastly, it reduced the effectiveness of monetary policy.

The President noted that the capping of interest rates had not met its intended objective, particularly in expanding credit access. Lawmakers’ have two possible courses of action. On the one hand, they could amend the Finance Bill, 2019 to repeal section 33 B. This will do away with the interest rate capping, and the Speaker shall re-submit it to the President for assent. The second option is to pass the Finance Bill, 2019 a second time without amendments, or with amendments that do not fully incorporate the President’s changes. This has to be supported by two-thirds of members of the National Assembly.

It is unlikely that the Executive will wield some political capital in order to convince MPs that repealing the interest rate cap is better overall for the economy. If the proposal to repeal the rate cap law is successful, one possible benefit is the growth of private sector credit. This is because banks will have sufficient margin to compensate for risks. Furthermore, credit and economic growth are positively correlated and with increased access to credit by MSMEs, the economy is bound to expand. Lastly, with the repeal of the rate cap law, CBK will be free to adjust the monetary policy rate in response to economic developments such as inflation and growth.

In conclusion, the rate cap legislation should be repealed because a free market, where interest rates are set by the forces of demand and supply coupled with increased competition from non-bank financial institutions for funding will see a competitive environment. This will be characterized by a reduced cost of credit and increased access to credit by borrowers sidelined by the current laws. However, after the repeal, there still needs to be consumer protection against abuse by banks and the promotion of alternative funding channels.