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Ideas & Debate

Rate cap has the whole world watching

Last Wednesday President Uhuru Kenyatta assented to the Bill capping interest rates at four percentage points above the base rate set by the Central Bank of Kenya.

Given the Central Bank Rate is currently at 10.5 per cent, the new law stipulates banks cannot charge more than 14.5 per cent on loans. The immediate effect of this decision is already being felt.

As of when this article was written, banks share prices on the Nairobi Securities Exchange (NSE) had plummeted by up to 10 per cent.

Given that a great deal of activity at the NSE is from foreign sources, the dip in prices signals that the world was watching Kenya on this issue and do not seem to like the direction taken.

However, the overall concern with the rate cap is the associated uncertainty. Banks themselves are trying to figure out how the new law will affect them and their operations.

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There are basic questions that are yet to be answered: will existing debt portfolios be affected by the law? Will regulated microfinance rates be capped? How will the new law affect lending?

This cap creates an aura of uncertainty going forward which is of particular concern given that Kenya is going into an election year which comes with uncertainty of its own.

Beyond the uncertainty, an issue that will be front and centre is whether the lower interest rates will actually expand access to credit.

In the mind of the Kenyan public, lower interest rates will translate to cheaper loans. What the public seems to be forgetting is that capping interest rates may make it harder to qualify for the loan in the first place.

There is a real possibility that the law will lead to a contraction of credit — banks will not lend to parties they feel are riskier than the stipulated 14.5 per cent.

Indeed, because rates have been capped, there is no margin of error for banks in lending decisions. Thus there is a real possibility that qualification requirements for credit will become even more stringent and onerous as banks seek to ensure that each lending decision is a sure bet.

So while there may be jubilation for the next few months, it may be short lived. Kenyans may find that getting that ‘cheap loan’ is not as easy as anticipated.

In short, it is conceivable that the credit market will be drier than was the case before the capping. There is a possibility of a broadening gap between credit demand and supply. Concern has been expressed on how such a credit gap may strengthen unregulated shadow lending mechanisms.

However, there is a silver lining. saccos stand to be the biggest winners from this interest rate cap. If the new law leads to lower access to credit from banks, many Kenyans may move to saccos to get the credit they need for their personal and business needs.

Other parties that can benefit from the unfolding scenario and potential credit squeeze are alternative financing institutions such as impact investors and equity funds.

Impact investors may find that fairly credible SMEs that were previously absorbed in mainstream credit markets are finding it harder to get the financing they need and can now be more readily financed through impact investment products. 

Equity funds may find that this is the tipping point needed for Kenyans to truly open up to equity financing.

In short, we see what happens. What Kenya can be sure of is that the world is watching this development and key lessons will be learnt from this, for better or worse.

Ms Were is a development economist. Email: [email protected]

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