Jul 23, 2017

Two recent events have led us to revisit the topic of the effect of the interest rate caps on credit growth and costs:

1. First, the Kenya Bankers Association (KBA) and the Central Bank (CBK) made public a Cost of Credit website in which commercial banks and micro-finance institutions are required to publish their true cost of credit, which revealed that the average true cost of credit is at 16.7%, and is as high as 20.6%, which is way above the statutory limit of 14.0%, based on the interest rate cap legislation that limit the lending rate to 4.0% above the Central Bank Rate (CBR), and,
2. CBK came out this week and set out new regulations that will see commercial banks incur heavy penalties, of up to a maximum of Kshs 20.0 mn, from Kshs 5.0 mn previously, for failure to disclose the true cost of credit to consumers.

Given that it is now almost a year since the legislation, this write up seeks to assess and update on the impact of the Banking (Amendment) Act 2015 on (i) the total cost of credit now versus pre-rate cap period, (ii) whether the interest rate cap has achieved its intention of improving access to credit, (iii) the sustainability of the rate cap, and (iv) what needs to be done to spur lending, and at what rates banks are willing to lend. We have already done three previous focus notes on the topic, namely,

1. Interest Rates Cap is Kenya’s Brexit – Popular but Unwise, which we published in August 2016, just before the bill was signed into law, making the argument that the free movement and pricing of labor, capital, goods and services, tends to be strongly correlated with stronger economic growth and prosperity,
2. Impact of the Interest Rate Cap, which we published in August 2016, right after the bill was signed into law, where we expressed concern that those who the amendment was meant to protect, might end up being the biggest losers, given banks would not be prepared to lend out so readily under the regulatory framework, and,
3. State of Interest Rate Caps, which we published in May 2017, making the argument that the interest rate caps have (i) locked out SME’s and retail borrowers from accessing credit, (ii) led to widespread lay-offs in the banking sector, (iii) strained the smaller banks, who have to mobilize expensive funds and can only lend out within the stipulated margins, and (iv) continued to weigh down on private sector credit growth, which stood at 4.0% at the time.

The total cost of credit is defined as all costs related to the issuance of credit, including interest and any fees tied to acquiring credit, usually expressed by the Annual Percentage Rate (APR), a metric that factors in additional costs and fees on the annual interest rate. The Banking (Amendment) Act 2015 was introduced in August 2016, capping lending rates at 4.0% points above the CBR and deposit rates at 70.0% of the CBR rate. The intention of the bill was to protect consumers from high cost of credit and not earning any interest on their savings accounts.

However, despite the positive intention behind the Banking (Amendment) Act, the impact has been negative, as can be illustrated in the following ways:

1. Decline in private sector credit growth from a high of 25.8% in June 2014 to 2.1% recorded in May 2017,
2. Decline in total amounts of commercial banks loan growth, with listed banks recording a loan growth of 7.1% in Q1’2017, compared to 15.7% in Q1’2016, and,
3. The average cost of loans by banks, as banks are now charging excessive fees and additional costs on their loans, which would only serve to discourage potential borrowers.

Decline in Private Sector Credit Growth: Since the Banking (Amendment) Act 2015 was introduced in August 2016, there has been a decline in access to credit, with the private sector credit growth declining to an 8-year low of 2.1% in May compared to 25.8% at its peak in June 2014, and a 5-year average of 17.7%. This decline can be attributed to the fact that banks prefer not to lend to consumers but invest in risk-free treasuries, which offer better returns on a risk adjusted basis.

Decline in Lending by Commercial Banks: The loan growth in commercial banks in Kenya has also been affected, with listed banks recording a loan growth of 7.1% as at Q1’2017, compared to 15.7% in Q1’2016 and a 5-year average growth of 14.6%. The most affected banks in terms of loan growth are those banks with a focus on SME’s and the retail market, the segment that the law was meant to protect, indicating the rate cap might not have achieved its intended objective. As stated in our Cytonn Weekly #33-2016, where we firmly disagreed with the rate capping proposal as a measure to make credit more accessible, we prescribed a market with free and open information on loan pricing and alternative products as effective methods to increase competition and drive down loan costs.

Historically, as shown in the chart below, the average rates for commercial banks loans and advances have been at 16.5% and 16.1% in 2014 and 2015, respectively, while the average rate in 2016 has come in at 16.5%, with interest rate caps introduced in August 2016, and have been fixed at 14.0% throughout 2017. When this is compared to loan growth, as shown in the chart below, it is noticeable that loan growth was highest during a time of no interest rate caps, dipping to 6.3% in 2016 when the interest rate caps were introduced, and we have seen this drag on into the first quarter of 2017, with loan growth at 7.1%. With loan growth coming in at 7.3% in the first half of 2016, also attributed to structural factors in the banking sector brought about by increasing Non-Performing Loans (NPLs) due to a challenging operating environment, it is clear that the introduction of the interest rate caps has not served to increase credit growth, which has worsened since the introduction of the rate caps. As such, free pricing of loans with no government interference is associated with higher credit growth, when compared to the fixed rate regime the economy is currently under, which has only served to subdue credit growth further.

Average Cost of Loans by Banks: In line with providing the market with information, and in an effort to promote transparency and control the total cost of credit, CBK and KBA have made public a website in which commercial banks and micro-finance institutions, are required to publish their Annual Percentage Rates (APRs), loan repayment schedules and any additional details on their loans. Loans with a 1-year duration, both secured and unsecured, should attract the maximum chargeable interest of 14.0%, but banks have managed to increase the true cost of credit with bank charges varying depending on the bank.

Moving to analyse the true cost of credit, with banks levying charges above the 14.0% capped interest rate, below we have the ranking of the cheapest and costliest banks, based on the APR, assuming an individual has taken up a personal secured loan, with the average APR in the sector under this category recorded at 16.7%:

Personal Secured Loan - Cheapest Banks
Position	Bank	Annual Interest	Bank Charges	Other Charges	APR
1	Guaranty Trust Bank	14.0%	0.0%	0.0%	14.0%
2	CBA	14.0%	1.0%	0.1%	15.3%
2	Habib Bank Zurich	14.0%	1.0%	0.1%	15.3%
2	I&M Bank	14.0%	1.0%	0.1%	15.3%
2	Middle East Bank	14.0%	1.0%	0.1%	15.3%
2	Oriental Bank	14.0%	1.0%	0.1%	15.3%
2	Paramount Bank	14.0%	1.0%	0.1%	15.3%
2	Victoria Commercial Bank	14.0%	1.0%	0.1%	15.3%
	Average	14.0%	0.9%	0.1%	15.1%

 

Personal Secured Loan - Costly Banks
Position	Bank	Annual Interest	Bank Charges	Other Charges	APR
1	Equity Bank	14.0%	5.0%	0.5%	20.6%
2	Barclays Bank	14.0%	4.0%	0.9%	19.9%
3	Prime Bank	14.0%	4.0%	0.4%	19.2%
4	Family Bank	14.0%	3.2%	0.8%	18.8%
5	Chase Bank	14.0%	3.0%	0.3%	17.9%
5	Eco-bank Kenya	14.0%	3.0%	0.3%	17.9%
5	NIC Bank	14.0%	3.0%	0.3%	17.9%
5	Spire Bank	14.0%	3.0%	0.3%	17.9%
	Average	14.0%	3.5%	0.5%	18.8%

When it comes to applying for a 3-year mortgage, the APR is elevated due to third party charges such as legal fees and other related costs, with bank charges remaining relatively unchanged, and an average sector APR of 18.9% under the mortgage category.

Mortgage - Cheapest Banks
Position	Bank	Annual Interest	Bank Charges	Other Charges	APR
1	ABC Bank	14.0%	1.0%	5.6%	18.2%
1	Guaranty Trust Bank	14.0%	1.0%	5.6%	18.2%
1	I&M Bank	14.0%	1.0%	5.6%	18.2%
1	Middle East Bank	14.0%	1.0%	5.6%	18.2%
1	Victoria Commercial Bank	14.0%	1.0%	5.6%	18.2%
	Average	14.0%	1.0%	5.6%	18.2%

 

Mortgage - Costly Banks
Position	Bank	Annual Interest	Bank Charges	Other Charges	APR
1	Equity Bank	14.0%	5.0%	6.0%	21.3%
2	Barclays Bank	14.0%	3.0%	6.3%	20.0%
3	NIC Bank	14.0%	3.0%	6.3%	20.0%
4	KCB Group	14.0%	2.6%	6.3%	19.8%
5	Chase Bank	14.0%	3.0%	5.8%	19.7%
6	Eco-bank Kenya	14.0%	3.0%	5.8%	19.7%
	Average	14.0%	3.3%	6.1%	20.1%

From the tables above we can draw the following conclusions and insights on the total cost of credit as highlighted below;

• The total cost of credit is quite high, given the excessive fees being charged by large portions of the banking sector, with these additional costs accounting for 12.3% of the total cost of credit in the sector, and 17.7% of the 10 costliest banks, and,
• The larger banks in the industry, which control a substantial amount of the loan book, are the costliest, and hence are able to sway the market, given the low customer bargaining power.

While interest rates have remained relatively stable at low levels, following the Banking (Amendment) Act 2015, private sector credit growth has continued to dip, coming in at 2.1% in May, from 3.3% recorded in March, and 20.9% registered in May 2015, as it is still better to lend to the government as the interest rates remain high on government securities, with a 5-year trading at 12.4%.

Given the current state of low lending in the economy, and that we are under a fixed-rate regime on interest rates, below are the initiatives that need to be taken to spur credit growth once again in the economy:

1. Repeal the Banking (Amendment) Act 2015, given the current regulatory framework has proved to be a hindrance to credit growth, evidenced by the continued decline of private sector credit growth, which is at 2.1% as at March 2017, compared to 5.4% when the amendment was introduced in August 2016,
2. Diversify funding sources, which will enable borrowers to tap into alternative avenues of funding that are more flexible and pocket-friendly. In more developed economies, bank funding accounts for just 40.0% of funding for businesses, yet in this market, bank funding accounts for over 95.0% of funding. Alternative sources of funding, especially capital markets based funding and competing alternative products need not only be developed but encouraged,
3. Consumer education, where borrowers are educated on how to be able to access credit, the use of collateral and establishing a strong credit history,
4. Increased transparency, in a bid to spur competitiveness in the banking sector and bring a halt to excessive fees and costs, with recent initiatives by the CBK and KBA, such as the stringent new laws and cost of credit website, being commendable initiatives, and
5. Improved and more accommodative regulation, such as the Movable Property Security Rights Bill 2017, which seeks to facilitate use of movable assets as collateral for credit facilities, allowing borrowers to use a single asset to access credit from different lenders.

While interest rates are currently at stable low levels, the risk lies in the rigid loan pricing framework that has seen the government crowd out the private sector and lock out “high risk” borrowers, with private sector credit growth now at 2.1% as at May 2017, which could end up impacting negatively on the economy because the private sector is a major job creator. Moreover, the free pricing of loans with no government interference is associated with higher credit growth, when compared to the fixed rate regime the economy is currently under.