The Market after the Interest Rate Cap

The enactment of the Banking (Amendment) Act 2015 in September 2016, that capped lending rates at 4.0% above the Central Bank Rate (CBR), and deposit rates at 70.0% of the CBR, came against a backdrop of low trust in the Kenyan banking sector. For starters, the total cost of credit was high at approximately 17.7% in August 2016. However, there was a notable decline to 16.6% on average in FY’2016, after the rate cap was introduced, yet the interest earned on deposits placed in banks remained low, at approximately 7.1%. Secondly, calls for capping interest rates were based on the high profitability in the banking sector because of high spreads between lending rates and deposits rates, which in 2016 was at a high of 9.5% according to the World Bank. As a result, in 2016, the Return on Equity of Kenyan banks stood at 24.5% above the 5-year Sub Saharan Africa (SSA) average of 15.4%. The Return on Assets, on the other hand, stood at 3.1% above the 5-year SSA average of 1.5%, according to the IMF. Lastly, the period was marred with several failures of banks such as Chase Bank Limited, Imperial Bank Limited and Dubai Bank, due to failures in corporate governance. Depositors were rendered helpless and unable to access their deposits in these banks, leading to negative public sentiment that necessitated regulatory action in the sector.

The interest rate cap has had a huge impact on Kenya’s economy since its enactment. The negative effects were a credit crunch for the private sector, reduction of loan accessibility, banks changing their operating models to mitigate the effects of the legislation and the reduced effectiveness of the Monetary Policy. However, it did result in the proliferation of alternative credit markets which was. Good thing.

The Finance Bill, 2019 was signed into law on 7^th November, 2019, repealing section 33B of the Banking Act which provided for the capping of interest rates at 4.0% above the Central Bank Rate. With the repeal, we expect to see the following benefits accrue to the economy:

1. Private Sector Credit Growth: As of November 2019, the private sector credit growth rate improved to 12.1%, from 11.4% recorded in September according to the MPC market perception survey. With the repeal of the rate cap law, there is an anticipation of improved market liquidity, coupled with improved macroeconomic environment, which is expected to support higher credit growth,
2. Increased Loan Accessibility: We expect to see an increase in the number of loan accounts as banks are expected to increase credit access to smaller borrowers. The repeal has seen commercial banks increase aggressiveness in marketing retail loans to customers and we expect more banks to continue with this trend,
3. Higher GDP Growth: Credit and economic growth are positively correlated and we expect that with increased access to credit by MSMEs, the economy is bound to expand as MSMEs make a significant contribution to the economy,
4. Banks Will Change Operating Models to Accommodate Effects of the Rate Cap Repeal: The repeal of the cap law will see banks recording higher interest income levels, as banks increase access to credit,
5. Continued Growth of Alternative Credit Markets: While the immediate effects of the alternative channels have been deemed predatory, we believe that the investments and progress made in developing the alternative channels will have positive long-term impact as an alternative financial services channel once the sector becomes regulated,
6. Reduced Accessibility of Government Debt Locally: With the rate cap in place, banks preferred to lend to less risky borrowers including the government through the purchase of government securities. We expect banks to increase their credit accessibility and admit riskier borrowers including SMEs and individuals, which will see a reduction in subscription rates for government securities, and,
7. Increased Accessibility to Mortgages: The introduction of the interest rate cap in 2016 saw an increased demand for mortgage loans due to perceived affordability by borrowers. We expect to see a continued increase in the value of mortgage loan assets outstanding, due to increased appetite for home ownership.

Going forward, we do not expect banks to reprice loans taken during the rate cap era. According to the Kenyan Bankers Association, most banks will not readjust their new pricing on commercial loans since banks have accepted their risk profile as an industry. However, we still recommend that we deal with the outstanding issues, one of which is consumer protection against abuse by banks, since the removal of the cap may set stage for the return of expensive loans that had risen to more than 25.0% before the rate cap. We also need to promote competing alternative funding channels, which will further increase access to credit for borrowers who are unable to access formal loans from banks.

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