Judges strike a blow for cheaper credit in interest rates suits

A new reality is dawning for Kenya’s commercial banks as consumers rush to the courts for protection against sale of their property over interest charges incurred on bad loans.

The lenders – long used to raking in super profits from unfettered interest charges – have in recent months lost millions of shillings in unrealised income after the courts declared their attempts to sell borrowers property to recover the money illegal.

In the past 36 months, banks have lost more than Sh100 million in interest income after the courts declared their dealings with borrowers were dishonest and bordered on usury.

At the centre of the suits has been a claim by the borrowers that the banks varied interest chargeable on loans contrary to the law that initially capped it at 100 per cent of the outstanding amount. But the banks have argued that the Finance minister had freed their hands in the matter through a gazette notice published in 2005.

Most have been found to have acted in breach of the law that requires them to notify and get authorization from the financial services sector regulator, the Central Bank of Kenya for any variations on interest charged on loans.

Most banks have lost huge amounts of revenue in court battles began after their customers defaulted on loans forcing them to attempt to exercise the power of sale of assets used to secure the loans.

Though the increase in interest charge related suits points to the difficulty that borrowers are facing in a battered economy, the loss of huge amounts of money in interest income – a major contributor to banking sector revenues – may leave a dent in the profitability of financial services sector.

Interest income currently accounts for about 70 per cent of commercial banks’ incomes and any slowdown in its delivery not only leaves the banks with less revenue but also forces them to increase their provisions for bad loans in their books of accounts.

Court records show that commercial banks have been facing a steady rise in the number of interest rate related suits from their clients with the assistance of advisory firms signalling how difficult it has come for lenders to post revenues from that side of their operations.

The rulings have not just been a wake up call for commercial banks but also pose the risk of their balance sheets being blown out of proportion by irrecoverable debt that without proper provisions would compromise the lender’s asset quality.

In one exceptional case, a commercial bank demanded from a borrower interest charges valued at 10 times the principle.

That the defences of some banks against alleged levying of irregular interest and penalty charges may be built on quick sand has come clear in the storm of suits with some banks having conceded to settle the disputes out of court to forestall reputational risks.

Before it was amended through a gazette notice in August 2005, the In duplum rule demanded that once a debt becomes non performing, interest stops accruing once the unpaid interest equals the unpaid principal -- in this case the outstanding obligation rather than the initial sum borrowed.

Although the Central Bank of Kenya monitors compliance with the In duplum rule through periodic returns submitted by all banks and site verification by CBK inspectors, its capacity to enforce the rule is limited.