How ‘vague’ law made saccos cut loan interest rates

Demand for cheap credit from customers prompted micro-finance institutions to cut the cost of lending despite being exempted from the rate cap law.

According to a policy research paper commissioned by the World Bank (WB) on request from the Central Bank of Kenya, the unclear wording of the interest rate cap law opened a window for customers to demand that savings and credit cooperative organisations (saccos) and micro-finance institutions (MFIs) cut interest rates on loans

“Several institutions interviewed as part of this study reported that customers demanded lower rates and were unwilling to pay more than 14 per cent, which they could receive from banks,” says WB.

The study says the 'vague language' contained in the Banking (Amendment) Act resulted in customers expecting compliance from deposit-taking micro-finance institutions (DTMFIs) and saccos.

According to the survey, which interviewed top DMFIs such as Rafiki Micro-finance Bank and Kenya Women Micro-Finance Bank, the institutions had to reprice their loans from as high as 22 per cent.

The micro-financiers also found themselves in a tight corner as the level of deposits dropped because customers took some of their money to banks in anticipation of higher returns. The DMFIs had to go for expensive money to meet their lending obligations.

“Deposits, which accounted for a large proportion of funding for DTMFIs before the enforcement of the Act, were drastically reduced. This resulted in lower liquidity and forced offshore borrowing at higher rates,” says WB.

However, the rush by customers to take advantage of the amended law that compels banks to pay interest on term deposits at the rate of 70 per cent of the Central Bank Rate backfired.

According to the report, there was a significant shift by banks to offering interest only on long-term deposits and eliminating any interest on current accounts.

“This shift is most evident among tier III banks, where interest-bearing accounts dropped precipitously to nearly zero per cent of portfolio in response to the interest rate caps, down from a previous average of 36 per cent,” says the study.

The study says that correspondingly, non-interest-bearing accounts increased by a similar magnitude to an average share of nearly 75 per cent, up from a pre-caps average of 38.9 per cent.

To remain competitive, saccos had to change tack. The study says that they had to reduce their rates in line with the caps to stay competitive and to retain their customers.

“Similarly, saccos are turning to technology or mobile solutions to reduce costs and are also looking to non-funded income to supplement reduced funded income,” the study adds.

Another contentious area in the Act has been whether or not mobile loans are part of the interest rate cap. The study found that while banks are adhering to the cap on their conventional loans, many mobile loans continue to carry effective interest rate charges of over 100 per cent per year.