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It is now a year since an amendment to the Kenyan Banking Act of 2016 capping interest rates on loans at 4% above the Central Bank rate – which stands at 10% – came into force.

Twelve months later the exercise has brought home sobering lessons for the Kenyan economy and the banking sector as a whole. The Central Bank of Kenya (CBK) is now contemplating reverting to the free-market regime that existed before capping was introduced.

The capping of interest rates was viewed as a populist move when enacted even though the proponents, had explained it as a cushion to protect consumers from high interest rates charged by banks at the time. Before the interest rate cap, Kenyan banks charged an interest rate spread of 11.4% which was 5% higher than the global average.

Even though there had been previous attempts to persuade banks to lower their interest rates, these had been unsuccessful until last year when Parliament unanimously passed the amendment.

At the time when the interest rates amendment became law, local private equity firm Cytonn Investment issued a warning that the move was bad for the Kenyan economy: “We are of the view that capping interest rates might solve the high interest rate spreads in the banking sector, but will lead to other challenges such as locking out of SMEs and other ‘high risk’ borrowers from accessing credit as banks will prefer to loan to the government, [thus] straining small banks who effectively have been shut out from the interbank market and now have to mobilise funds at rates higher than what they are getting and can only lend out within the stipulated margins.”

The statement concluded: “We believe the amendment will do more harm to the economy than good.” In mid-September this year CBK Governor Patrick Njoroge admitted that the government was contemplating reversing the move to allow for free market policies to reign again.

“It is in our interest as a country and as CBK, to work to reverse these measures and go back to a regime with freely determined interest rates but in a disciplined environment,” he said.

This was not entirely unexpected as during the interest rate capping debate in 2016, Njoroge had opposed the move noting that it went against the principles on which the Kenyan economy had been based since independence.

It was in early March this year that the initial signs of the impact of the interest rate capping began to be seen and felt as decreased lending became evident. All of Kenya’s top five banks – Equity, Kenya Commercial Bank, Cooperative Bank, StanChart and Barclays – reported a drop in their earnings.

Profits squeezed

When lenders listed at the Nairobi Securities Exchange (NSE) released their reports for 2016, it was clear the interest caps had squeezed their profits. Barclays Bank of Kenya recorded a fall of 12% on its net profits, while Stanbic Holdings Kenya announced a 10% drop.

Banking stocks continue to fall more steeply than in previous years and this decline has been blamed on the interest rate capping and the country’s election cycle. Kenya held its Parliamentary and Presidential elections in September but the Kenya Supreme Court annulled the results of the Presidential poll following a petition by the losing candidate, Raila Odinga. As African Banker went to press it was uncertain whether the re-run scheduled for October 26 would take place.

Presaging the elections, The Financial Sector Stability report released by CBK in August stated: “Domestically, the election cycle generally impacts financial stability and growth prospects, especially if results are contested.

“This, coupled with geopolitical and macroeconomic instability in some East African countries where Kenya’s financial institutions operate and the trade links are strong, is more likely to be a source of vulnerabilities going forward… As a result the stock market is likely to record further depressed activity.”

As the interest rate cap marks a year since it came into force, an internal CBK study has already indicated tougher times for the banking sector and the multiple ripple effects on the Kenyan economy.

While the CBK admits that its study has shown that an interest rates freeze is bad for the economy, it is yet to release the full findings for public scrutiny. An increase of non-performing loans has already elicited worry from the International Monetary Fund (IMF), which has asked the CBK to be vigilant and requested that the Treasury remove the interest rate caps as small banks and borrowers are facing a crunch time.

Problematic issue

“I think it is clear to us that this interest cap has been problematic in many ways.” Njoroge says. “It is in our interest as a central bank to work to reverse these measures and go back to a regime where interest rates are freely determined but in a disciplined environment.”

The fact that small banks have been badly affected has prompted the New York-based credit rating agency, Fitch Ratings, to sound an alert on the Kenyan economy.

“Banks have become more selective about who they lend to and have lost the incentive to grant long-term loans and finance emerging economic sectors, as the cap means that the rate will be the same as for safer short term loans,” says the agency. “This is a threat to growth in the Kenyan economy which relies heavily on bank lending and private sector credit growth which had been flattening since 2015, has slowed since the rate cap.

“Small banks are worst affected as they are more reliant on higher risk return loans and sectors and some are finding that their niche business models are no longer viable.”

But supporters of the cap have strongly defended the measure. Kiambu Town MP Jude Njomo, who led the campaign to curb interest rates in Parliament, said: “There is a concerted effort by banks, which have formed cartels to keep off credit from the public thus blackmailing Parliament into changing a law that protects the ordinary people.”

One of the fiercest critics of the capping, the IMF, which had said that “these controls have had unintended negative consequences on the availability of financing for small and medium-sized enterprises, with the risk of reversing the remarkable increase in financial inclusion observed in recent years,” itself came under attack from some quarters.

Stephen Mutoro, the Consumers Federation of Kenya (COFEK) Secretary-General criticised the IMF for its sustained tilt against the rate cap and added that failed IMF policies were to blame for the sad state of Kenya’s banking. The Kenya Bankers Association (KBA), on the other hand, warned that banks were likely to divert more funds towards Treasury bills and “other opportunities in the forex market” rather than lending to borrowers, as government debt is considered less risky and more profitable.

There is no doubt that when the rate cap was announced one year ago, it met with a good deal of public approval as rampant interest rates before then had priced local capital out of the reach of the majority of small traders in the country.

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from African Business Magazine http://ift.tt/2AvBamL