CBK could soon abolish law on interest rates cap

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Kenya’s 18-month-old cap on commercial interest rates could be repealed in the next two months as it emerged that it may have cut last year’s estimated economic growth rate by 0.4 percentage points, and starved small and medium enterprises of cash.

Last week, Central Bank of Kenya (CBK) Governor Patrick Njoroge said that the law could be repealed as early as June, in a bid to rejuvenate the country’s credit sector which has recorded a slowdown. The rate cap law was passed in August 2016 in response to the high cost of credit.

“We will be talking to all the stakeholders, including parliament and the bankers. The pointers will be on how this law will be amended or repealed. We are doing this in our interest as a country,” said Dr Njoroge.

The EastAfrican understands that several consultative meetings between bankers, legislators and government officials have suggested tweaking the law on both the deposit and interest rate as they seek to have a win-win scenario for both the banking sector and customers.

The main point of discussion has so far been on the deposit rate, where legislators in the Parliamentary Budget Office are said to have agreed to have it as the first point of review.

Last week’s Monetary Policy Committee (MPC) decision to lower the CBR by 50 basis points was also viewed as a market test, as this cut the deposit rate too.

“The removal of the floor on deposit rates would allow banks to negotiate with their customers. This will also give the banking regulator some wiggle room. We have come to a situation where we all agree we will have some sort of regulation but one that allows flexibility,” said head of the parliamentary budget committee Kimani Ichung’wah.

It is understood that one of the suggestions that the legislators are toying with is to reduce the base rate on deposits from the current 70 per cent to below 50 per cent so as to give banks room to price their risk.

On the other hand, Treasury, which is caught in catch 22 situation, given the rise in the volumes of banks participation in its papers vis-a-vis the private sector credit crunch, is keen to have this rate not go beyond 30 per cent.

“The discussions are no longer on whether we should reduce the ceiling on the current deposit rate but by what percentage. Treasury is keen on consumer protection with an outlined deposit rate ceiling which cannot be breached by banks. There is also the discussion on the ceiling on the interest rates to give banks wriggle room too, on the pricing of their risk premiums but this isn’t as loud as the deposit basing cap removal,” The EastAfrican was told.

Total repeal

Kenyan banks have however said that they will be seeking a total repeal of the interest cap law that has impacted on their profitability and reduced shareholder earnings.

Through their umbrella body, the Kenya Bankers Association (KBA), the bankers said the controversial legislation has prompted banks to avoid lending to riskier segments such as individuals and SMEs and stifled growth of the economy.

“Obviously the most appropriate possibility is to completely repeal the interest rates law because it has not been effective. Any partial amendments to the law will only create more problems and complications going forward, which will then send us back to the negotiating table,” said KBA chief executive Habil Olaka.

Early this month, Treasury Principal Secretary Kamau Thugge said they were thinking of a law that would address the issues of consumer protection and previous concerns on loan costs, calculations and issues in the financial system.
“This will be addressed in a fundamental way to bring the rates down in a sustainable way,” said Dr Thugge.

Review of the law

In its report in February, the Parliamentary Budget Office gave the clearest indication that they will be supporting a review of the law noting that it has affected the flexibility of the CBR, the key monetary policy tool. This was a climb down from its October last year rejection of any repeal of the law.

“We are going to introduce reforms that will bring back market-driven interest rates while at the same time protecting consumers from adverse rates. These reforms will help us extend credit to the private sector,” said the National Treasury Cabinet Secretary Henry Rotich.

Last week, CBK released a new report on whose basis it is seeking public comments on the legal caps ahead of the planned review of the rates capping law.

The report paints an adverse picture of the impact of the 18-month rates cap including a drop in loan accounts resulting in rising average loan size by 36.7 per cent.

“The rising value of loan size vis-à-vis reduced number of loan accounts reflects lower access to small borrowers and larger loans to more established firms,” the report notes.

CBK also says that during the rates cap regime, the commercial banks investment in government securities has increased while the share of credit to the private sector has continued to decline.

Other effects of the rates cap has been the significant decline in capital for smaller banks.

“Tier III (small size) banks recorded the largest capital erosion after interest capping. This may be attributed to reduced earnings that impacted on capacity to build-up capital. Tier I banks (large size) have maintained high capital build-up levels. Tier II (medium size) banks appear to have been affected by instability in late 2015 and ‘new normal’ requirements,” the banking regulator says.

The rates cap has also seen the profitability of the banking sector decline. The return on equity touched the lowest level of 19.8 per cent in February last year with return on assets reaching the lowest level of 2.3 per cent in January last year.

The decline in earnings over time may pose risks to financial stability through increased balance sheet risks reduced capacity to build capital buffers to absorb shocks.

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