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Will micro-lenders be affected by caps on interest rates?

As a development economist I have natural interest in microfinance institutions (MFIs) because they have been an important story in Kenya’s journey towards financial inclusion.

And while I am of the view that interest capping is a dubious bet rife with risk that may harm Kenyans and the economy more than it can help, a key question has emerged in this debate: Are interest rate caps going to be applied to MFIs should they be effected?

This question is pertinent for two reasons. First, mwananchi — in whose interest MPs apparently passed the Bill — tend to borrow more from MFIs than commercial banks.

Secondly, due to the business model of MFIs, interest rates and more importantly annual percentage rates (APRs), are particularly high.

Indeed last year, the Central Bank of Kenya (CBK) data showed that micro-lenders were on average charging 22.6 per cent on loans compared to 16 per cent by banks.

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Finally, there is a grey area which prevents the classification of entities as either strictly commercial banks or strictly MFIs.

If one looks at the CBK list of what is classified as commercial banks, some on that list brand and market themselves as MFIs and target similar customer groups as MFIs. Thus, if such ‘‘commercial’’ banks will potentially be affected by interest rate capping, why shouldn’t MFIs in general?

These issues are important because if only commercial bank interest rates are capped, it may engender a shift of loans from the MFI docket to the commercial banks docket as Kenyans seek the best deals possible.

Trapped with MFIs

However, in that shift thousands of low-income Kenyans may leave a docket that was designed with them in mind particularly in regard to loan size.

So either Kenyans will be trapped with MFIs with much higher interest rates but the right loan size, or they risk moving to a bank that has lower interest rate but does not have a loan size which is manageable or relevant thereby locking them out of credit. This seems a raw deal for mwananchi either way.

On the other hand, if the interest-rate cap applies to MFIs it will compromise their ability to serve low-income Kenyans.

This is because MFIs typically process very many small loans compared to commercial banks because poor Kenyans can typically service only small loans. Because of this, MFIs tend to have higher overheads in terms of outreach and processing costs leading to higher interest rates.

Secondly, is the issue of non-performing loans (NPLs) where the argument is that as MFIs target a less financially secure group, the risk of NPLs is higher than a commercial bank which focuses on corporate clients, for example. Thus again, upward pressure is exerted on interest rates in MFIs.

These factors explain why the CBK data showed that micro-lenders charge more on loans than regular banks. Thus, if capping interest rates apply to MFIs there will be pressure to lower overhead costs which may compromise how many loans can be processed which will likely translate to a lower volume of loans being awarded thereby contracting credit supply for low-income Kenyans.

Further, MFIs will be less able to take on riskier clients as there will be very limited wiggle room in terms of NPLs. So again, how does the common man benefit from interest rate capping?

There is need for more clarity on which institutions will be affected by interest rate capping in order to better manage potential ramifications so that Kenyans, especially low-income earners, get the best deal possible. 

Were is a development economist. [email protected]

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