Decisive moment for cheap loans as interest rate cap rule put on trial

Central Bank of Kenya(CBK) Governor Patrick Njoroge.

In 2015, the Netherlands shocked the world when it decided that bankers must swear an oath to God to tame their excesses and pledge good conduct in their dealings with clients.

Globally, bankers are willing to go any extra length to engineer complex financial schemes and in the process put economies at risk to make an extra shilling. However, they will still get bailed out by taxpayers.

In Kenya, their appetite for huge profits amid tight competition in the banking sector has seen lenders make money even when the economy is crumbling. When one defaults on loan payments, the banks will not hesitate to auction your property.

Kenya, though not as dramatic as the Netherlands, has a Central Bank Governor Dr Patrick Njoroge, a religious ideologue, who says he has found a way to make local bankers walk the straight and narrow road.

This comes at a time when some banks have been found culpable of keeping fake gold and currencies in bank safety deposit boxes for clients. Lenders have also been accused of complicity in transferring stolen cash from various scandals such as that of the National Youth Service, which saw a number of them fined.

Indeed, banks had been charging Kenyans as high as 35 per cent interest on loans prior to the rate cap ceiling. This excesses to maximise on returns is the key reason why in the first place the caps on interest rate came into being.

Dr Njoroge, however, wants Kenyans to put their faith in him and allow the apex bank to rein in lenders’ greed and lift the interest rate caps. He promises a change in as far as charges on interest loan are concerned. He reckons banks, currently restricted at a maximum rate of 14 per cent, will offer better terms on loans to clients that have a good credit rating. Thus, hinting at a loan rate of between 10 per cent and 13 per cent for borrowers who have a good credit rating.

For the governor, things in the banking sector are changing for the better. He believes that though bankers were prior to the rate cap selfishly concerned about their profit, they are now willing to accommodate the concerns of their customers.

“Let me take you back to 2008 after the global financial crisis... what did we say about bankers, that they were not ethical and they will never change. They love their money and their whiskey,” reckoned Dr Njoroge.

“But today, it is now standard to do ethical training, there are many things that are now standard for the board, management, and directors and you can see the world is now a better place. I just want to make the point that because things are difficult, it doesn’t mean that we should not do them,” he said.

Njoroge cares about the people of Kenya and the economy within which they operate. He has thus renewed push for lenders to use credit scores when charging interest on loans. Should this be implemented, borrowers with positive credit rating will get better terms, most likely lower than the current 14 per cent.

Conversely, Njoroge wants interest rate cap that has enabled Kenyans to get cheaper loans scrapped. Removal of interest rate controls would undo all the gains good borrowers might have started enjoying by using credit scores to determine interest rate charged on loans.  As the push to put an end to interest caps gains momentum, borrowers are worried that they might never get to enjoy 14 per cent interest rate should the ceiling be removed, irrespective of a promise by the Governor to ensure lenders adopt credit scores when giving loans.

Njoroge’s illusion that banks have changed just to convince Kenyans and Members of Parliament to finally lift the rate cap has left tongues wagging. The interest rate capping law has been one of the most underestimated pieces of legislation in its ability to survive.

It was dismissed when Kiambu Member of Parliament Jude Njomo brought it to the floor of the house as destined to suffer the fate of the Donde Bill and all its predecessors, but went through despite strong resistance by the money men.

Assumed that it would die before assenting at the desk of President Uhuru Kenyatta whose family owns a bank, others believed that it would die due to pressure from the International Monetary Fund or at the risk of losing access to the Bretton Woods facility.

But this law has ducked these missiles and as it approaches its third birthday, it risks being entrenched as the norm.

Not so fast, a surprise ruling from the courts almost sniffed life out of the law when a three-judge High Court bench ruled that it was unconstitutional, or at least sections of it. The courts, however, gave the rate cap law a saving grace of 12 months, for MPs to amend it or let it die a natural death. Now the fate of the law has moved to the Court of Appeal.

The approach that the CBK boss has chosen is two-fold — attack the law in the Court of Appeal, while convincing the country it is unnecessary to free interest charges as bankers have agreed to play by the rules of the book. “In effect, what cannot happen is when the interest rate caps are removed we go back to the same old habits. The old ways of doing things, maybe we should all read Things Fall Apart, the old ways is no more,” Njoroge argued.

He proposed a new model to govern the banking sector. He reckons that the model would achieve the regulator’s vision that hinged on four pillars, of adoption of customer-centric business models by banks, risk-based pricing of credit, enhanced transparency and information disclosures and entrenching an ethical culture in banks.

Njoroge noted that this approach has been informed by analysing approaches in other jurisdictions including the UK, India and South Africa and Namibia as well as the outcome of surveys and investigations on customer protection. The apex bank boss announced that the CBK Charter created last year will make borrowing even cheaper when it comes into force.

On February 28, last year, CBK issued the Banking Sector Charter on Banks, microfinance and mortgage institutions representing a commitment by the banks and microfinance to entrench a responsible and discipline banking sector culture.

It became effective on March 1, this year. These institutions are required to develop time-bound plans approved by their boards and they need to submit this to CBK by May 31, thereafter they are required to submit quarterly reports showing progress in implementing the new charter.

Key in this charter is the rule on risk-based lending which will force banks to measure your risks and if you are a good borrower the bank must give you a lower interest rate than the maximum 14 per cent on offer. This means a good borrower must get loans at rates lower than 13 per cent.

“Risk-based pricing revolves around reviewing the Credit Reference Bureau regulations also compelling banks to use positive credit information in credit pricing,” DNjoroge said. “There is always a lot of pain when making progress in a particular area, but if you entrench it, it becomes a lot easier. It is not the difficulty that is the problem but how quickly the banks can embrace the charter,” he said.

The charter compels banking institutions to come up with a plan of implementation, including the publication of hidden charges on their loans. It also compels the banks to commit to increasing lending to small and medium-sized business by at least 20 per cent by the year 2020.

Individual borrowers

The regulator in the draft charter admonishes the banks which have been reluctant to use credit scoring techniques and instead preferring to put all individual borrowers on the same risk bracket. This allows them to charge a high interest rate for personal loans.

“The use of appropriate credit scoring techniques shall be ascertained by CBK through various avenues, including on-site examinations and through conducting consumer protection diagnostic exercises like mystery shopping surveys,” indicated CBK in its draft charter

Analysts Financial Standard talked to, however, express doubt that using risk-based lending may not improve on the amount of loans banks offer to the public since they may still use the risk system to reject borrowers.

“Every bank in the world already uses risk-based pricing for roughly 450 years now. So we should be very keen to see what has been developed in this revolutionary laboratory. When the realities of those risks do not appeal to the powerful, they have throughout history tried to game the system, and always the gaming has failed,” one analyst who declined to be named explained.

In fact, lenders have argued that even if the rate cap is reviewed, they would only offer blanket prices for mortgages, secured loans and long-term loans but that approach would find it difficult to price an individual.

Instead, they have tendencies of using the credit information sharing mechanism negatively as a blacklisting tool.

This is despite advancement in credit profiling. For instance, Metropol, the biggest Credit Reference Bureau in the country, has developed a loan auction where when you need a facility, you post it on their website and participating lenders can give offers from which the borrower can pick the most favourable rate.

“When the rate cap came in, we were slowed down, but we are still improving it,” said Metropol. CBK also said despite joining hands with the Kenya Bankers Association to create a transparency website, some lenders have not yet uploaded their cost of credit.

Failure to do so will see the regulator invoke its powers to slap banks with fines of up to Sh5 million, dislodging their boards or management and even instituting other remedial measures granted under its Banking Act gambit. The Governor opined that CBK has been busy since September 2016, taking steps in the strengthening of the banking system to make it more efficient.

Dr Njoroge is convinced that commercial banks will even convince their shareholders to accept lower dividends for the greater good of the economy. “We must entrench in shareholders the culture of accepting lower returns in equities and investments,” Dr Njoroge said.

But the tricky question in the minds of many borrowers is will the bank owners and shareholders endorse this plan? Barclays Bank boss Jeremy Awori said the lenders were under pressure to perform given the fluidity of investments that may see money migrate to other competing sectors of the economy if they fail to deliver.

“If banks are not giving returns, the money will simply go elsewhere,” said Mr Awori during the release of the lender’s results.

A banker who did not want to be named said there was too much confusion on how some of the CBK’s proposed changes will be applied. Meanwhile, from what we know is that the banks have always found a way around efforts to pin them down.

In 2016, the rate cap law had a component where banks were supposed to pay 70 per cent of Central Bank Rate on deposits. Immediately they changed the classification of deposit accounts to transactional accounts which earned zero interest.

To ensure they made money under the rate cap environment, banks have resorted to taking advantage on accounting changes such as the IFRS 9, balance sheet reorganisations around costs where thousands of staff were sent on early retirement.

This saw the banks continue making huge profits, even after they lowered the amount it lent to Wanjiku. Costs saving also came from getting cheaper funds, which meant squeezing pension and insurance funds for cheaper deposits and punishing small savers with little or no interest.

Having cut private sector credit, the main source of income for banks has been lending to the government. It is unlikely that the lenders will charge lower interest rates than those prescribed by the law and if the rate cap is removed there is no guarantee interest rate would remain at 14 per cent or below.

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