Loans: Banks fail self-regulation test

Co-operative Bank banking hall in Nairobi.[David Njaaga,Standard] Banks have over the last week been falling over themselves to reduce their lending rates but only after the Central Bank of Kenya (CBK) threatened to penalise them for failure to pass on the benefits of lower interest rates to their customers. The developments mirror the past, where the banks sustained high costs of loans, with some charging as high as 35 and 40 per cent annually but would react whenever the regulator threatened to cap rates legally through an Act of Parliament. Central Bank's Monetary Policy Committee (MPC) earlier this month cut the Central Bank Rate (CBR) to 10.75 per cent from 11.25 per cent. MPC has since August last year sustained a reduction in CBR. The apex bank, however, noted that despite the cuts, banks remained reluctant to reduce interest rates, which was, in turn, hurting the economy. CBK threatened to penalise the banks that did not cut their lending rates. It went on to say it was inspecting five banks for failing to pass on lower borrowing costs to customers. Non-compliant banks face fines of up to Sh20 million or three times any undue benefits accrued. CBK was recently given the teeth to bite after the Business Laws (Amendment) Act, 2024 amended the Banking Act, varying the penalties that the Act had prescribed for non-compliance among banks and other financial services institutions to include a penalty equivalent to three times the gross amount of money earned through non-compliance. CBK increased CBR in 2023 as it sought to tame inflation that was trending at around nine per cent, an objective it now notes has been met and the lowering of the benchmark rate is aimed at spurring lending to households and firms. The regulator also reduced the Cash Reserve Ratio (CRR) by 3.25 per cent from 4.25 per cent, which it said would complement the lowering of the CBR and support the lowering of lending rates. National Treasury Cabinet Secretary John Mbadi last Thursday noted the impact that high interest rates by commercial banks have had on the economy. "We have not seen a lot of expansion in the job market as we would want to see because extension of credit to the private sector has been depressed throughout 2024 and in fact contracted by 1.4 per cent," he said. "Bank lending is one channel through which the monetary base would expand and liquidity would be realised in an economy. Given the outcome of inflation, which is at 3.3 per cent, CBK has gradually eased the monetary policy by lowering the Central Bank Rate from 13 per cent in August 2024 to 11.25 per cent to 10.75 per cent in February." He explained that lowering the cash reserve ratio, reduces the balance commercial banks need to maintain at CBK. "It means you are releasing more money for banks to loan to the Kenyan public and that has the effect of improving liquidity. This reduction alone will make over Sh50 billion available to commercial banks to lend to Kenyans to carry out their businesses, provide employment and improve the general liquidity in the economy," said Mr Mbadi, adding that banks have now reduced interest rates to reflect the decline in CBR. "Interest rates have reduced in line with the easing of the monetary policy. The reduction of interest rates by banks is likely to expand credit to the private sector, encouraging investments, creating jobs and improving the general liquidity in the general economy." The lag between the drop in CBR and the lowering of interest rates by banks points to a historical challenge, whereby lenders have had to be threatened with regulation before passing such benefits to borrowers. The push and pull witnessed between the Central Bank and the lenders in recent weeks rekindled the fight for lower interest rates over the years, particularly since economic liberalisation in the 1990s. At some point, the clamour for cheap credit has taken unexpected turns culminating in the capping of interest rates in 2016. Most memorable perhaps was the Donde Act - more famous as the Donde Bill before it sailed through Parliament and was later signed into law - which was sponsored by former Gem legislator Joe Donde. It became law in 2000, but the Central Bank (Amendment) Act, 2000 - as it is known officially - did not, however, take effect with the dates contained in the Act causing confusion. While the Act was signed in August 2001, it had a commencement date of January 2001. Banks moved to court for interpretation and it was declared void due to the retrospective commencement date. At the time, the law had capped interest rates at four per cent above the 91-day Treasury Bill rate. It was not until 2016, nearly two decades after the flop of the Donden Act, that Jude Njomo - the then-MP for Kiambu Town - introduced a similar bill in Parliament in 2015, which sailed and came into force the following year. The Banking (Amendment) Act, 2016 capped interest on bank loans at four per cent above the CBR. This would have meant that with the CBR at 10.75 per cent as per the last MPC meeting, banks could only lend at a maximum of 14.75 per cent. Just as is the case today where banks have complied after threats of penalties by the Central Bank, in the lead up to the singing of the 2016 interest rate capping law, banks had committed to lower interest rates as they lobbied MPs against passing it and President Uhuru Kenyatta from signing it into law. The banks in 2016 presented a Memorandum of Understanding (MoU) to CBK in which they committed "to enhance industry regulation and transmission of the CBK Monetary Policy, promote pricing transparency and support enterprise development." The MoU, the banks said, provided guidelines that sought to offer practical solutions to the interest rates debate while still retaining free market principles. By capping interest rates, the Banking (Amendment) Act, 2016 was aimed at availing affordable credit to Kenyans, especially small and medium enterprises as well as households. It, however, worked against the lawmakers, with banks denying them loans and instead increasing lending to the government through Treasury Bills and Bonds. Eventually, the cap was removed in November 2019. Central Bank, despite its threats this month to banks for failure to lower lending rates last week, has always opposed capping interest rates. In a March 2018 report, about two years after the interest rate caps came into effect, it noted that the law had the effect of denying businesses and households credit. It noted that following interest rate capping, several borrowers were shunned by banks, and the number of loan accounts had significantly reduced. Lending to large enterprises, however, increased, with the average loan size increasing by 36.7 per cent. "The rising value of loan size vis-a-vis the reduced number of loan accounts reflects lower access to small borrowers and larger loans to more established firms," said CBK in 2018. "Investment in government securities has increased since the inception of the law: The share of commercial banks holding of government securities has increased while the share of credit to the private sector has continued to decline." Aside from the attempts by MPs Donde and Njomo, there was another to cap lending rates during former President Mwai Kibaki's regime when the then-Finance Minister David Mwiraria introduced the in duplum rule in 2004. The in duplum rule rule was a legal provision aimed at protecting borrowers by limiting the amount that a bank could recover on a non-performing loan. The provision prevented lenders from charging excessive interest and noted that interest on a loan should not exceed the principal amount. "Since 1989 when the Banking Act was amended to remove the power of the Central Bank of Kenya (the CBK) to regulate interest rates, the question of whether or not interest rates should be regulated is one that has occupied Kenyans. In 2001, the Donde Act reintroduced regulation of interest rates. This law was declared by the courts to be void for having a retrospective commencement date," said law firm Bowmans in a past analysis on capping of interest rates, adding that the law that came into effect in 2016 drew "ire and support in equal measure." It added that at the time, those who supported the capping of interest rates argued "that it was necessary to tame predatory lending" as before the 2016 Act, "the rates charged by commercial banks in Kenya were some of the highest in the world and that they were uncontrollable, unpredictable and exploitative". The firm also noted arguments against regulating interest rates had pointed out that the law did not "deal with the fundamental issues of costs of credit and ease of access; that the provisions have stifled credit and negatively impacted the economy."

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