In 2016, Kenya capped bank interest rates, which meant borrowers could not be charged beyond a certain rate. Few wanted to say it loudly, but the rates were controlled.
No one wanted to appear old fashioned. I am one of the few who stuck their heads out and opposed the move. I argued that the move made political but not economic sense.
The law was celebrated, seen as revenge against banks that charge more to borrowers compared with depositors. That spread was seen as too big. But the law had unintended consequences.
The cap made it easier for the government to borrow in two ways. One, the rates were lowered and economic law of demand suggests more was borrowed because of the lower price (lower interest rate).
Two, the banks preferred to lend money to the government; it was risk-free unlike lending to me and you. Governments rarely default. And needless to say, there is less hustle lending to the government, it’s just one!
Individuals, small and medium enterprises are more likely to default. They have no experience like big firms and are more affected by the changes in the wider environment. They have not diversified and competition is tough. Visit Gikomba. To compensate for their high risk, lenders charge them a higher interest rate but the rate cap denied banks that liberty. They thus chose borrowers whose risk was closer to the interest rate prescribed by the capping.
The cap has been repealed after a relentless fight by banks. The International Monetary Fund and some economists also argued that the cap made monetary policy impotent. Others say in whispers that the banks won because of who owns them.
The three years in which the cap was in force was a bold experiment and economists should thank the MPs for sponsoring the expensive experiment - by chance. We found the Kenyan market can be peculiar, to quote Safaricom’s founding CEO, Michael Joseph.
Given that individuals and small enterprises could not easily access bank loans, they had to seek alternatives. We often forget that we don’t borrow money because we are reckless, at times reality demands so. If your child is sick, power or water cut off, you have no time to think about the interest rate, you solve the problem first.
Any behavioural economist knows there is an unreasonable part of us, better called irrational. The online lending platforms know this and seem to have fully anticipated the unintended consequences of the interest rate cap. And they made their money. First because of the irrational part of us and two, they cut through bureaucracy. If you have tried to borrow money from the traditional banks, you know the hustles and paper work. One bank wanted my CV. Was it to try and understand the irrational or rational part of me?
Online lending platforms have another huge advantage; they are not regulated by Central Bank. That allowed them to adjust their interest rate to reflect the risk of the borrowers. They became innovative, even using artificial intelligence to predict your creditworthiness. Their operation costs are almost zero, mostly transacting using M-Pesa.
In the bold experiment, we learnt how entrepreneurs take advantage of any available opportunity to make hay when then sun shines. Online platforms made money as banks complained, with catchy names drawing in customers.
By repealing the cap, we are accepting it did not work. We never got Kenyans queuing outside banks to get cheap loans and the government debt ballooned. By shifting money to government papers - treasury bills and bonds - the private sector which is often more efficient than the public sector was denied credit and growth.
Is that why we are asking where all the money has gone? A good PhD student should investigate what Kenyan GDP growth would have been without the rate cap and nepotism. Now that the cap has been repealed, we have another experiment on how to undo a bad decision.
And banks are yet to uncork champagne. Why are they putting out full page adverts reminding us that the old loans will be repaid using old rates? What did one bank mean by “existing market conditions”? Is this a coded message that the rates will rise?
But wait a minute: Economic laws will now come into play. If rates go up, fewer individuals will borrow. That could also give banks a bad name. Is that why they are putting up big adverts? Part of psychological warfare?
It gets more interesting. Suppose online platforms reduce their rates to converge with those of banks so that a borrower is indifferent between the bank and themselves? What if the platform rates become normal?
How they react to the interest cap repeal is the second phase of the bold experiment in our financial sector.
My hunch tells me that banks should hold back their party, not yet. As long as the online outfits are innovative, have low costs and understand our behaviour - perhaps better than banks - they remain a competitor to mainstream lenders. Banks even learnt from these online platforms by starting their own!
And why can’t we be bolder and turn these online platforms into virtual banks? We are yet to get our Amazon and Alibaba equivalents in the financial sector. The resulting competition will bring down the interest rates and spur economic growth.
The myth that Kenya is over-banked is just that. Has the number of banks grown commensurate with the recent census? In fact, banks are consolidating, reducing competition further.
The fallout from the rate cap is yet to play itself out. We are watching and waiting. What is not debatable is that economists and financial analysts have never had it so good. It’s still a morning in Kenya’s financial sector.
- The writer teaches at the University of Nairobi
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