Is Parliament justified in quest to fix commercial bank interest rates?

The recent increase in commercial banks’ lending rates has drawn an outcry from the Kenyan public.

Currently, the lowest base lending rate charged by a bank in Kenya is 24 per cent per year whereas the effective rate is above 27 per cent - with some banks charging as high as 32 per cent plus processing fee.

The rates on deposits vary from zero per cent to 17 per cent, depending on the amount deposited and the period of the placement.
Until August 2011, on average, the highest lending rate was at 16 per cent per year whereas the highest interest rate on deposits stood below 10 per cent per annum.

Looking at the above scenario, it is true that during the last four months, the rates have almost doubled, making borrowing very expensive for Kenyans. The soaring lending rates have spurred members of Parliament to formulate a Bill that will cap them.

The legislators want lending rates fixed at a maximum of Central Bank of Kenya (CBK) rate, which is 18 per cent, plus 4 per cent bringing it to 22 per cent.

They also want the interest on deposits fixed at a maximum of 70 per cent on commercial banks’ lending rate , that is 70 per cent of 22 per cent which brings it to 15.4 per cent.

The argument put forward is that by levying very high interest rates, banks are stealing from the public while reporting supernormal profits.

If the Parliamentarians wish to control the interest rates, they should first thrash out three issues:
What is the cause of the current high interest rates?

What role has CBK played in pushing the interest rates up?

What will be the effect of fixing interest rates?

Since the Governor of CBK assumed office, he has been asking banks to reduce their lending rates but banks have been reluctant to do so.

To counter the reluctance, the Governor raised CBK’s rate of lending to commercial banks (CBR) to 18 per cent in a bid to control inflation and the depreciation of the Kenya shilling. The commercial banks followed suit by adjusting their lending rates upwards.

Some critics have said that since CBK is a lender of last resort, commercial banks should not rely on it to lend them money to meet their liquidity positions unless it is an emergency.

This means that commercial banks should manage their liquidity positions by using their customers’ deposits. Through their umbrella body, Kenya Bankers Association, they should be able to sort out their liquidity problems without resorting to CBK.

What has not been explained, is why the inter-bank rate is sometimes much higher – as high as 32 per cent – than the CBK lending rate and yet the funds are coming from members of the association?