Regulations designed to prevent usury, or the taking of "excessive" interest, have been debated from the time of Prophet Mohamed in the Islamic world.
In Islamic countries, usury is actually forbidden by law in accordance with the Quaranic instructions. That is why Muslims prefer to borrow through Shariah-compliant lending systems that prohibit excessive charging of interest.
Today, as a result of a prolonged period of high inflation, record interest rates, and sluggish economic growth, the usury ceilings in effect in many countries are the centre of controversy least of all, Kenya.
In 24 African countries, Central Banks have put a cap on interest rates. Are the critics of these usury ceilings simply speaking out of self-interest when they argue that interest rate ceilings work to consumers' disadvantage by restricting credit flows and distorting financial markets? Do usury ceilings protect consumers from abusive lending practices and enable them to obtain loans at reasonable rates, as their advocates claim?
My opinion is yes, consumers are protected when they are guaranteed a predictable pattern in paying back their debts. It makes it easy to manage debt.
The proponents of interest rates ceilings are acting to protect the poor against predatory banks out to sponge off the poor. There is a feeling that those who argue in favour of not capping interest rates are mainly stakeholders in the banking sector and therefore do not want to see this regulation take effect.
Since the days of Joe Donde, for once it is impressive that MPs have passed a pro-poor Bill. A few years ago former Gem MP Joe Donde drafted a Bill with similar objectives. It didn't see the light of day. The intrigues are a subject of a case study on how the monied can gang up against the downtrodden where their interests are at risk. Kiambu MP Jude Njomo's Bill picks up where Mr Donde left.
Were President Kenyatta to assent to this Bill, interest rates charged by banks would be capped at four per cent above the the Kenya Banks' Reference Rate (KBRR) published by the Central Bank of Kenya. Currently, the CBK benchmark rate stands at 11.5 per cent.
Mr Kenyatta according to State House, is still studying the Bill. Currently, banks charge as high as 30 per cent in some cases making credit facilities prohibitively expensive to most of the people. Due to high interest rates, a large number of people have failed to pay their debts leading to default.
In truth, the current lending regime is punitive. Figure this out; if someone took a mortgage to finance a house costing around Sh15 million, estimated monthly instalments using current rates are at least Sh300,000 for ten years. That is ridiculously costly.
At the end of it, the loanee will have paid Sh36 million. This is about two-and-a-half times the actual price of the house at the time of purchase.
If the same borrower offered his house for rental, it would hardly fetch more than Sh70,000 shillings per month. That shows that there is a huge anomally between real market value and pricing. That alone could explain why the mortgage market in Kenya is negligible.
According to the Housing Finance Company about 25,000 people have taken a mortgage in a country of about 40 million people. Evidently, people are shying away from borrowing due to the prevailing high interest rates.
For most business, unregulated interest rates have consequences. If the business does not know its future interest payments or earnings, then it cannot complete a cash flow forecast accurately. It will have less confidence in its project appraisal decisions because changes in interest rates may alter the weighted average cost of capital and the outcome of net present value calculations.
The governor of CBK has a point when he expresses reservations about capping interest rates. Many micro-finance institutions (MFI's) would be pushed out of business and in the long run people in the lower income category might face a challenge in getting a loan facility or might be forced to borrow from the informal lending groups which are not regulated and borrowers might be charged even a higher interest rate.
Yet in today's Kenya, the banking sector is the most profitable. When posting their earnings, most banks indicate extremely high profit returns. Are they are reaping off borrowers? Ideally, banks make their money from lending hence the simple connection
For example, in the six months of 2016, Banks made Sh71 billion. A third of that could end up as taxes, but still that remains a huge chunk.
I see a middle ground where we have the CBK giving a benchmark and the law is set in such a way that banks fluctuate between those points. So say, plus 5 per cent of the KBR rate. Banks then compete for customers based on that. It works in America or Australia and the UK. Why not in Kenya?
If a ceiling were to be put on the interest rate, this could lead to some levelling mechanism where banks reduce their profits and people earn more money from their savings from the lowered interest rates.
Currently, interest rates are based more on the fluctuations due to changes in the market dynamics. This is what the banks take advantage of. That needs to stop.
