Those who have been campaigning against the interest rate cap over the last one and a half years have set up an elaborate strategy to either do away with it altogether or radically water it down.
This conversation is happening behind closed doors, with opposers crafting rules that will decide what interest will be charged on the Sh2.4 trillion the country has presently borrowed.
While the final say lies with Parliament where Kenyans hope MPs will be on their side, the current reforms are building up to be a negotiated pact informed by a group of liberal thinkers bent on getting the law out of the way.
The International Monetary Fund (IMF) has been unequivocal that Kenya must ditch the cap or kiss the Sh150 billion ($1.5 billion) standby loan goodbye.
IMF Senior Economist Nikko Hobdari in a recent address to Parliament recommended the abolition of the rate cap, saying it will interfere with economic growth, especially debt to the private sector.
“Data from banks show there has been a big decline in lending. There has been a drop of 10 per cent in lending to SMEs,” Hobdari said.
When the Financial Standard inquired whether IMF would support a tweaking of the law rather than a complete repeal, IMF Country Representative Jan Mikkelsen said he ‘believes they have already made their views clear and had nothing to add at the moment’.
However, the impossible trinity means a country must choose between free capital mobility, exchange-rate management and an independent monetary policy. Only two of the three are possible. Lenders’ lobby, the Kenya Bankers Association (KBA) says the ideal situation would be the removal of the rate cap.
KBA Chief Executive Habil Olaka said lenders are open to a compromise - where they could trade off with provisions of the law and have it altered.
“I cannot say the point at which we are but it is certainly a conversation and people are collecting views and evidence,” Olaka said. Decreased lending by commercial banks has however seen micro-lenders such as Branch, Tala (formerly Mkopo Rahisi), Saidia, Zidisha among others and fill the gap with use of one’s profile to offer loans.
This is in addition to the Savings and Credit Cooperative Societies (saccos) filling the void.
Barclays Bank CEO Jeremy Awori observed that dialogue is already underway and they will push it in earnest in the coming days weeks and months.
“As an industry, we are looking at a series of different alternatives but we can work with the government to come up with a system that is actually good for our country, borrowers and customers,” Awori said.
Financial Standard has also learned that the most concrete discussions revolve around the removal of the base rate of 70 per cent of the Central Bank Rate and pushing the ceiling as far up as 30 per cent to allow banks to price risks.
Sources at Treasury indicate that the State wants to push for a consumer protection ceiling rate of up to 30 per cent where banks will not be allowed to breach while relying on other measures to bring the borrowing rates down.
“The issues of consumer protection will be addressed in some sort of a law to address the concerns that were there before - that the SMEs are not getting loans at reasonable rates and the issues in the financial system will also be addressed in a fundamental way to bring the rates down in a sustainable way,” Dr Thugge said in Nairobi on Thursday last week.
Parliament has also warmed up to the review of the rate cap with Budget Committee Chair Kimani Ichung’wa, proposing that the removal of the floor on deposit rates would allow banks to negotiate with their customers and give the central bank some wiggle room. “We must come to a situation where we all agree we will have some sort of regulation but one that allows flexibility,” Ichung’wa told Reuters recently.
The law capping interest rates took legislators almost two decades to achieve. Gem MP Joe Donde lost the battles in 1990 and three presidents failed to sign legislation meant to discipline banks.
Though the Donde Act was even assented to by President Daniel Arap Moi, it was fought in court. Banks managed to throw the law out over legal loopholes criminalising the charging of excessive interests on loans.
While the problem persisted, Finance Minister, the late David Mwiraria tried to insert the in-duplum (equitability) in the Banking (Amendment) Bill 2004 which would apply to loans as far back as 1990 which was not assented by President Mwai Kibaki.
The Banking Amendment Act (2006) which proposed a ban on bank charges within savings accounts and also had the in duplum rule however managed to become law. When the test came to President Uhuru Kenyatta’s desk, he was facing an election.
His family was associated with Commercial Bank of Africa and the interest rates had soared.
Despite the lenders warning of fire and brimstone, and that consequences could include credit becoming unavailable to some consumers and the possible emergence of unregulated informal and exploitative lending mechanisms, President Kenyatta signed it.
While this has come to pass, it has not fundamentally been at the massive scale predicted by lenders.
Saccos have played a major role in absorbing the extra demand and the gross domestic product grew despite lending to the private sector slowing down to two per cent.
This made the government reluctant to act, given that it would look like it had sided with banks and the fact that lenders had over the last couple of decades demonstrated that when left to the invisible hand of the market they would manipulate profits to their end.
Another reason why the government was reluctant to act is that as a result of the rate cap, the National Treasury has been getting money cheaply.
Banks could not lend to risky customers at 14 per cent, so they flooded the bonds and bill market outbidding each other to give the state cheap credit.
“The Government is staring at a double-edged sword. The rate cap stampeded the banks into Government of Kenya Paper (treated as risk-free on the balance sheet) and any tinkering with the rate cap will surely taper bank demand for Government Paper,” said Rich Management CEO Aly-Khan Satchu.
This factor underscores why removal of the rate cap is a great risk to all borrowers while its reform should be closely watched since it could mean going back to high rates.
As suggested, taking the determination of rate caps back to the liberal market will mean that borrowing rates will be quoted at the rate at which government is borrowing which is considered risk free plus a premium on each borrower. But as was seen in the third quarter of 2015, when the government borrowed aggressively, the risk-free Treasury bills soar and normal market rates also jump.
But when the State slows down on borrowing, banks take their time to cut lending rates.
Bankers want us to believe they have learned their lessons over the past one and a half years and that they will not revert to the old habits.
“I think the banks appreciate that status quo ante is a no-go,” Satchu said.
The legislators, however, seemed to differ, citing reservations given the history of banking in Kenya.
“Can banks be trusted to self-regulate? I don’t think they can because they are profit-motivated,” Ichungwa said, adding that the current lending rates would probably remain,”
While the rate cap review is under discussion, some analysts say giving lenders a free hand without any framework in place will reverse the intentions that led to the rate caps in the first place.
Mr Deepak Dave of Riverside Capital suggests that interest rate capping and floor should be retained for small depositors and borrowers and all pensioners.
“Therefore, if you save below Sh1.5 million or borrow for less than one year or borrow below Sh3 million for less than two years, then the cap-and-floor applies,” Deepak said.
He said the ceiling and floor should be applied to everyone over 65, with those limits doubled for the amount, not the term. “This way, the benefits are focused on those with small savings, small borrowings, and vulnerable to short-term uncertainty. Everyone else, particularly large corporates, are subject to market forces,” Deepak said.
He observed that those limits are subject to change in budget, but never with less than six months’ notice (it means each year speculative behaviour is not encouraged).
“Other countries such as India, China, Brazil, Peru etc do similar things using either specific locations, industry sectors or income levels. For our less mature economy, I believe the simplest is the below,” Deepak explained.
He said the rest of the borrowers should also be protected by CBK enforcing conditions such as the need to charge a rate on a facility on the behaviour of each individual rather than punish good borrowers to pay for bad borrowers by adopting the same interest rate across products.
Mr Awori said that at present, banks could only do segmentation of clients and not treat each borrower as an individual and per his her credit profile as envisioned under the Credit Reference Bureau structure.
“I think over time that’s inevitably going to happen for two reasons, one is for competitiveness one really needs to reward and recognise people who are a lower credit risk and give them better pricing and your ultimate segment is the segment of one,” Awori said.
“But we know to get down to a segment of one is going to be hard, so what we will end up with is groups of customers who probably have a similar risk profiles but also dovetails into IFRS 9 which requires to look at future anticipated losses and you will have to do the same exercise with regards to sub-segmenting your customers profiles,” he said. Barclays Bank has invested in robotics which offers it an opportunity to use artificial intelligence and data analytics to get better at understanding clients and get better at pricing those clients for their loan products.
“The challenge we have with the interest rates cap today is that it is fairly blunt it doesn’t look at different tenors, it doesn’t look at different types of loans, secured and unsecured,” Awori said.
“It doesn’t look at the risk profile of customers, so what it does is that it cuts out the riskier clients who in any normal financial system you price for risk if you are a riskier client you pay slightly more if you are a good borrower you pay slightly less.”
He noted that when the rate cap wave swept the country, people were focusing on the highest price but segmentation was always there since a global corporate client was not paying the same as an unsecured retailer.
“I think what was in dispute was the price for some of the riskier segments and I think that is where banks have already started working on the efficiencies of their operations. We need to see if we can pass those efficiencies on to an affordable price for clients,” he said.
Mr Satchu said that with Parliament on board, reforms on the rate cap or its complete repeal is a matter of when and not if it will happen.
“I was concerned that the political arena had not moved the dial in this matter. However, Ichung’wa’s comments are a signal that we can expect some tinkering,” Satchu said. He said the banks’ share price action is confirming movement that the market is anticipating some surgery of the rate cap.
CBK will also need to relook at whether to create another rate apart from the Central Bank rate on which to form the basis of the new rate cap.
Using CBR has complicated the monetary policy since CBK has not been able to change the policy since September 2016. Mr Satchu said the rate cap has muddied monetary policy. “Typically, CBK would be lowering rates at this point in the economic cycle to stimulate growth. However, the rate cap has blocked this avenue and therefore yes, we need to look at how we reduce interference in monetary policy-making and signalling,” he said.