Borrowers stare at high rates as Central Bank of Kenya eyes free market

Confident businesswoman calculating tax at desk in office

Borrowers who rushed to take advantage of the attractive borrowing rates may be startlingly staring at expensive loans if the banks will be handed a free hand in the pricing of loans.

Central Bank of Kenya (CBK) Governor Patrick Njoroge, who on many occasions has hit out at lenders over high interest rates, now says it is clear that Kenya is headed back to free market forces and that the cap was only to be temporary.

“It is in our interest as a country and CBK to work to reverse these measures and go back to a regime with freely determined interest rates.

It is clear to us that this has been problematic in many ways. I can tell you the direction but I cannot tell you when,” says Dr Njoroge.

The ‘when’ remains unanswered but its impact on the consumers and the economy may be huge.

The cap on interest rates a year ago attracted more new customers to banking halls while those who were repaying loans benefited from reduced rates and even topped up their facilities.

According to Consumer Federation of Kenya (CofeK) Secretary General Stephen Mutoro, CBK and National Treasury have not addressed fears that led to the cap ceiling and its removal may ‘sink’ consumers into a crisis of expensive loans.

“If we remove the caps, interest rates will go up to about 30 per cent and take us back to the same agonising banking stories. The elephant in the room is lack of competition. Banks sit together and fix interest rates,” says Mutoro.

He points out that CBK and the National Treasury have not addressed the fears which necessitated a regulated bank interest regime. “The bankers had a long to-do list to help bring down the cost of credit but nothing much has been done,” says Mutoro.

However, CBK boss, a former advisor to the International Monetary Fund’s  Deputy Managing Director, says removing rate caps will not amount to throwing consumers under the bus.

Running an economy with the rate cap in place, Njoroge likens the experience to that of driving an old car whose engine is defective or driving a new car with strict instructions to use only one gear.

“It is like you have been given a car and told you can only use the third gear. You can’t go uphill. We are really constrained. We are asking for flexibility in the economy. The economy needs all the gears and the consumers will benefit,” says Dr Njoroge.

He insists that lower interests are good for the economy and that should the rates go up, he will ensure there is discipline so that the high rates won’t be re-introduced.

However, he appreciates that with the cap, most loans are now concentrated at 14 per cent, a pointer that should the cap be removed, most banks may want to push the rates higher.

“Of course there will be concerns that we will have to manage. All I want is loans to be priced correctly. If indeed any customer is riskier, why should they be free riders?” asks the CBK boss.

Risk profile

Bank executives have argued that it has been problematic to loan to customers whose risk profile is above 14 per cent. Dr Njoroge feels that if banks use all available tools, customers will be priced correctly and exorbitant rates may never arise.

Dr Njoroge says that he wants to introduce discipline in the market so that banks can properly capture risk profile of customers. “We want to move to a more disciplined credit market. What we saw in pre-rate cap regime was a level of high indiscipline by banks,” says the governor.

The level of indiscipline was that of banks charging customers as high as 25 per cent as interest rate on loans, which at times made consumers repay more than double the borrowed amount.

Kenya Bankers Association (KBA) Chief Executive Habil Olaka says concurs that the law had to be passed because of high interest rates. 

“As an industry, we have tried to address the issues that were raised during the debate on the law,” Dr Olaka said in a recent TV interview.

He cited the launch of cost of a credit website, saying that it allows customers to compare pricing of loans across the sector to make informed decision.

However, Cofek boss feels that CBK is yet to address the “non-transparent pricing of loans” and reduction of the cost of credit in Kenya.

But the CBK boss asserts that once rate caps are removed, he will ensure proper operations in the credit market so that banks do not slip back to the status quo. “We are pushing banks to improve their lending practices. They have to be more business oriented. In particular, they have to price risk properly when they lend,” said CBK boss.

He says that CBK has already had discussions with banks on their new business models in the quest for much a better-disciplined behaviuor in the credit market to yield favorable rates.

The governor feels that banks have been paying little attention to areas such as customer credit history.

He says that the Credit Reference Bureaus (CRBs) that were meant to help customers have not been of much use. “There has been no much consideration about credit history. CRB report has been used as a black-listing operation just like you get a red card in a soccer match and you are out,” says Njoroge. 

Mutoro is in agreement with CBK boss saying that banks are dishonest. He says that even though rate caps may not be the long-term solution to the problem, banks will have to fix their transparency first.

The Cofek secretary general is challenging the governor to ensure discipline in the credit market just like he has done on overnight lending and the foreign exchange market.

Private sector

“Rate cap should be a lasting solution as long as changes towards instilling discipline in the sector are not done. Why can’t governor instill discipline first then push for the repeal?” asks Mutoro.

Prior to the capping of interest rates, KBA, the lenders’ umbrella body had signed a memorandum of understanding with CBK on how to lower interest rates. In addition, banks had committed Sh30 billion to small and medium enterprises.

According to KBA, he cap interfered with their plan to SMEs. “The controls on rates complicated matters but only in regards to the proposed lending of Sh30 billion at 14.5 per cent for SMEs.

With Parliament choosing not to engage with the industry but to proceed with the capping of interest rates, this proposal was nullified,” KBA told Financial Standard.

The most glaring concern in the country has been tight conditions for accessing credit. The growth of credit to the private sector has been on a decline since August 2015 even as rates of default rose.

The downward trend however reversed last month with a slight increase of 1.6 per cent from 1.4 per cent in July. CBK boss says the marginal recovery is good news and he is crossing fingers that it persists.

According to Britam Asset Managers, the longer the rate caps stay in place the greater the magnitude of credit contraction which will put the anticipated double-digit economic growth at risk.

However, Britam cautions that in the absence of alternative framework, banks may be tempted to hike rates since they are already sending signals that they are constrained in pricing risks.

“It is a kind of a catch-22- situation where when the rates are low, banks are not lending but when they are high, that acts as a barrier to access credit,” says Britam Asset Managers CEO Kenneth Kaniu.

CBK’s Monetary Policy Committee (MPC) has already received preliminary findings of the studies on the slowed lending and the impact of the rate cap.

However, it has made recommendations and hopes that the final study will be made public in 14 days. “We all know an artist never finishes his work.

They simply walk away from their painting,” says Njoroge who chairs the MPC as he appeals for patience in the market.

Developmental economist Anzetse Were says the concept of capping rates was a populist idea generated in an election year and has hurt the financial sector which contributes about 10 per cent to the Gross Domestic Product.

Banks have slowed lending, with some having announced job cuts and frozen new employment while others have shut branches. Yet still, others have merged to be strong even as they invest in digital offerings. With the cap, Aly-Khan Satchu, the founder and CEO of investment advisory firm, Rich Management, opines that the sector is now carrying some “zombie banks” hoping to attract investors to rescue them.

Reversing the law will require that CBK makes the application through National Treasury which will, in turn, take it to the Parliament. President Uhuru Kenyatta, who went against National Treasury and CBK position to sign it into law, has already pointed out that he has seen the negative impact of the cap.

He has the numbers in Parliament but is headed to a repeat poll on October 26.

Barclays Bank of Kenya CEO Jeremy Awori says that going back to a free market regime is good for the economy but adds that high interest rates are not good for anyone. He sees the reversal, if any, taking longer.

“I don’t see it happening this side of the year because it has to go back to Parliament,” he says. The question of ‘when’ is weighty to the borrower.

CofeK says that banks have teamed up with CBK, National Treasury and International Monetary Fund to put the borrower on the chopping board.  Which way for the consumer?