New Bill seeking to fix borrowing rates in Kenya misguided

It is foolish to legislate prices. Full stop. Yet that is what Members of Parliament are trying to do with the recently passed Bill that puts a cap on interest rates at no more than four percent above the indicative Central Bank rate. The ill-advised Bill also sets the minimum interest earned by deposits at 70 per cent of the Central Bank rate. In brief, this is a populist Bill that will serve no more than create more problems for Kenyan borrowers.

By passing the Bill, MPs betrayed a singular lack of understanding of how interest rates work. Several factors contribute to the observed market lending rates. These include the latent risk faced by banks – Will borrowers pay on schedule? What is the nature of the collateral that debtors borrow against, and how are they reliable? How efficient is the legal system in dealing with defaulting debtors? How reliable is the data on borrowers’ credit history? On top of these factors, there is also the question of structural variables like projected economic performance, the extent of government borrowing, and alternative investments from which banks could be making more money.

There is no doubt that the banking system in Kenya needs a thorough clean up. The first months of Governor Patrick Njoroge’s tenure is proof of this fact. But we must do it right. Populist moves that seek to limit market mechanisms are certainly not the way to incentivise more lending to Kenyan households and businesses.

If MPs really want to streamline borrowing and lower the risks faced by borrowers, they should be thinking critically about the following.

First, many Kenyans use land and other property as collateral. How about we make the land registry and logbooks credible? Ensuring the security of property rights will significantly boost market transactions. It will also ease the cost of lending for banks, while at the same time lowering interest rates for borrowers. But these are reform efforts that MPs do not want to touch. They require working against cartels that ensure fuzziness at the land registry for their own benefit. And MPs simply have no time to do their homework on these issues.

Second, Kenya needs a 21st century commercial legal system, fully fitted with bankruptcy laws that give risk takers a second chance. Streamlining commercial laws will bring certainty to the debt recovery process when debtors default. It will also ease the bankruptcy process and give risk-taking entrepreneurs second chances. Again, thinking critically about how to reform the practice of commercial law in Kenya – through legislation and further reforms in the Judiciary – requires more work than waheshimiwa are willing to put in.

It is far easier to pull a number of out a hat – four percent – and get populist about it. The country is lucky that Governor Njoroge and Treasury Cabinet Secretary Henry Rotich have come out against the Bill. President Kenyatta should heed their advice and refuse to sign the Bill into law.

Lastly, several structural variables limit the extent to which banks can lower borrowing rates. Key among these is the extent of government borrowing. Our project deficit for the fiscal year 2016/17 is likely to hit more than 9 per cent of GDP. That means the government is scheduled to borrow a lot of money. A significant chunk of this money will come from banks. And the banks will lend the government money at very high rates – upwards of 20 per cent. So what makes MPs think that banks will refuse to lend money to the government at such high rates, and instead lend the money to households and business at 14.5 per cent?

Again, the fix here should be to focus on lowering the fiscal deficit and associated borrowing that crowds out the private sector. At the same time, MPs should strengthen contracting laws and the capacity of policymakers. More policy stability, predictability, a solid protection of property rights, and reduced government borrowing will help lower borrowing rates. Not a price fix by fiat.