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.

Repeal of this law – commonly known as the In duplum rule – to remove the limitation of interest charges has however offered little relief to banks in the corridors of justice.

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.

“The Central Bank is not aware of any commercial bank that has breached section 44A of the Banking Act (limit of interest to be recovered on defaulted loans),” said Fredrick Pere, the CBK director for Bank Supervision.

The director invited borrowers to address complaints on adherence by banks to the In duplum rule to his office.

Mr Pere said a wide array of remedial measures exist when banks violate statutory and prudential requirements.

These measures include issuance of directives, withholding of corporate approvals, removal of officers and directors and levying of penalties.

Prudential regulations issued by the bank consider a loan non-performing when the principal or interest is due and unpaid for 90 days.

The purpose of the rule is to protect the debtor who is in financial difficulty and is unable to service his debts from accumulation of interests and from exploitation by the creditor.

“It provides a temporary relief only as the escalation of the interest is merely tempered by the rule,” said Cathy Mputhia, an advocate of the high Court. “The biggest culprit that we have dealt with is penalty charges, where the bank goes against the contractual agreement with their clients by introducing irregular charges that are not provided for in the contract,” said James Mwangi, a consultant at Interest Rate Advisory Centre, one of the firms that recalculates interest rates on mortgages, personal and business loans.

For years banks have shielded themselves behind the fine print on loan contracts especially one that says the interest rates and charges can be varied without recourse to the borrower, a position that legal experts say has no basis in law and persists because of consumer ignorance.

“The law is supreme even when there is a contract. The biggest problem is reinforcement and control that is lacking,” said Gichuki King’aru, an advocate of the High Court who has handled many cases against banks.

In one case interest rate was revised to 40 per cent to which a penalty of 18 per cent was loaded for every delay in payment.

The interest Rates Advisory Centre says it gets 10 new cases related to flouting of the In Duplum rule every month, a tip of the iceberg because many borrowers suffer in silence.

A lawyer who talked to the Business Daily but could not be quoted due to involvement with various banks says many Kenyans walk blindly to banks, and are only too happy to receive a loan without understanding the terms and conditions.

“If it is stipulated in the contract that once a borrower defaults, it attracts a penalty rate, it is up to the borrower to settle the arrears because it will continue to accumulate,” said the lawyer. It is presumed that borrowers understand the contents of contracts before signing the dotted line.

“Once you sign a contract, it is a promise to the bank that must be fulfilled. It is expected that a borrower will repay any loan they seek from bank,” said John Wanyela, the Kenya Bankers Association executive director.

But besides diligently servicing the loan, many borrowers do not scrutinise their statements and fail to notice new entries or variations to the account.

In one such case the contract did not stipulate some of the bank charges, such as commissions, ledger fees and what the bank called miscellaneous debt forcing the plaintiff to overpay more than Sh220,000.

With a slowdown of the economy due to spiral effects of the global recession, post election violence in 2008 and prolonged drought, many Kenyans grappling with high inflation and job uncertainties have been forced to review their spending with long term financial obligations taking a back seat.

Companies have not fared any better with cash flows constrained by flat or marginally higher turnover and increased competition forcing them to reschedule some of their debts.