Interest rates cap to hurt consumers

A businessman who needed millions of dollars to clinch an important deal went to church to pray for the money.
By chance, he knelt next to a man who was praying for $100 to pay an urgent debt. The businessman took out his wallet and pressed $100 into the other man’s hand. Overjoyed, the man got up and left the church.

The businessman then closed his eyes and prayed, “And now, Lord, that I have your undivided attention...”

Towards the sunset of last year, two gentlemen got our collective, undivided attention. Rangwe Member of Parliament Martin Ogindo and his colleague Jakoyo Midiwo, the Member of Parliament for Gem. Both legislators want to introduce interest rate caps to the banking industry and the figures being tabled are a minimum of 70 per cent of the prevailing Central Bank Rate (CBR) as payable on deposits and a maximum of four per cent above the CBR to be charged on loans.

First let’s put things into context. Prior to the year 2000, the only clients enjoying credit from the banking industry were small, medium and large businesses, majority of whom had to provide security in the form of assets to secure such borrowing.

The few retail (individual) customers that had loans were also borrowing against a form of security in the form of a residential house, cash or government securities. At the turn of the century one brave bank stuck its neck out and introduced unsecured loans to individuals.

The premise was as simple as it was obvious. Avail a loan to a salaried employee and use their pay slip as the comfort source of repayment. Ensure that you ring-fence the risk of default by first obtaining a letter from the employer confirming that the employee is indeed genuine, then directing the employer to credit the employee’s salary to an account at your bank.

As the banking industry slowly began to take up what soon became apparent as an easy money-spinner, other non-banking institutions began providing salary check off loans leading to a working population that was now footloose and fancy free on the cash front.

Slayed dragon

The rest, as they say, is history. Consumerism fuelled by discretionary spending gallantly strode into our economy. Suddenly, our supermarkets could expand their product offerings into the non-traditional areas such as furniture and electronics since customers now had access to cash to buy the goods.
Second-hand car lots sprang up around the city faster than a Nairobi Water Company pipe leak as salaried employees both old and new to employment had access to cash to upgrade their wheels or get new ones where matatus had hitherto been the only transport of choice.

But two legislative gladiators on a chariot have come to ostensibly slay the insatiably greedy banking industry dragon. But can that dragon be slayed? You see, the banks have shareholders to whom they have promised a return and a regulator—the Central Bank —who has provided a banking licence to operate.

Both the shareholder return and banking licence are premised on the assumption that the bank’s management will exercise utmost care and caution in assessing the credit risk of default on loans that are given using customer deposits and on the strength of the bank’s capital.

As a result, you cannot force a bank to give a loan where the return does not compensate for not only the credit risk, but also the overall cost of doing business, and a profit margin as well. Similarly, you cannot force a bank to take term deposits at a prescribed rate.

What the brave legislators are trying to achieve will essentially undo the phenomenal access to credit over the last decade by the ordinary mwananchi. Banks will simply stop taking term deposits.

At 70 per cent of CBR, term deposits will be too expensive and not worth the grief. Savings accounts and fixed deposits as we know them will disappear and customers will only have access to current accounts for demand deposits.

Due to the fact that a large pool of relatively long-term deposits will no longer be available, medium to long term loans such as mortgages, construction loans and loans to buy equipment will also reduce significantly, as a prudent bank carefully monitors tenor mismatches on its balance sheet, that is, how its short-term assets (loans) are financed by short-term liabilities (deposits or borrowings from other institutions) and long term assets are matched by long term-liabilities. On the loan side, banks will view the price cap as not worth the risk.