Tough times for banks as Uhuru caps cost of loans

Kenyan banks were yesterday thrown back to the drawing board for a new business model after President Uhuru Kenyatta hit their biggest source of income — interest rates — with the signing into law of a Bill that caps the cost of loans.

Mr Kenyatta shocked financial markets with the late afternoon decision that was contrary to expectations that he would reject the Bill and send it back to Parliament.

The President said in a statement that he had taken the unorthodox position after carefully weighing the options before him.

“Upon weighing carefully all these considerations, on balance, I have assented to the Bill as presented to me. We will implement the new law, noting the difficulties that it would present,” he said.

By signing the Bill into law, Mr Kenyatta is seen as having chosen to stand with ordinary Kenyans who have long carried the weight of highly priced loans and brushed aside the advice of technocrats, including the Treasury chiefs and the Central Bank of Kenya governor, who had lobbied him to reject the Bill capping interest rates at four per cent above the indicative Central Bank Rate (CBR) and sets the deposit rate at 70 per cent of CBR.

If the law comes into force immediately, interest rates will drop to a maximum of 14.5 per cent given the CBR’s current standing at 10.5 per cent. Banks will also pay depositors 7.35 per cent interest on their money — forcing upon them the narrowest spreads since Kenya liberalised its financial markets in the early 1990s.

At a maximum of 14.5 per cent, the interest rates will be significantly lower than the current average lending rate of 18.3 per cent, and nearly 10 per cent cheaper for those currently servicing personal unsecured loans at an annual rate of 24 per cent.

Borrowers now have to wait for the Attorney-General to gazette the Act in seven days, complete with the effective date, to start enjoying the lower interest rates.

READ: Equity Bank's half year profit up 18pc to Sh10bn

READ: Banks says rate cap to lockout 40pc of new borrowers

It remains to be seen how the banks will navigate the controversial issue of migrating current loans to the new interest rates regime.

This is because most borrowers are currently on a flexible interest rates regime — meaning their interest rates vary according to the prevailing market conditions — and therefore the expectation that they will be moved to the new regime of a maximum 14.5 per cent once it comes into force.

Mr Rotich Wednesday declined to comment on the President’s action and instead referred all questions to Attorney-General Githu Muigai, who did not pick our calls.

Mortgage borrowers stand to be the biggest beneficiaries given the tenor of their loans.

Technocrats had warned that signing the Bill into law would force banks to stop lending to borrowers perceived to carry a high risk of default and who are mainly found in the personal loans and small and medium sized businesses segment of the market.

Mr Kenyatta said the government will move in to protect such borrowers from being pushed to the exploitative informal market dominated by shylocks but did not disclose the details.

With interest rates capped, most banks are expected to funnel most of their cash into government securities which are risk-free and lucrative at current rates of 10 per cent.

Tame its appetite for local debt

The burden will be on the Treasury to tame its appetite for local debt to ensure it does not crowd out the productive sectors of the economy from the loans market.

Two large banks, Equity and Standard Chartered, have already announced increased lending to government and a reduction of the personal lending, signalling the direction the industry is likely to take.

“The logical factor that banks might apply given the new regulations to sustain their margins would be to lend to the government — with the current 364-day T-bill rate going for 11.8 per cent — given increased appetite for government funding,” analysts at Sterling Investment Bank said.

The cap on interest rates puts Kenya in the group of more than 40 developing and transitional countries as well as more than 14 European countries, including Germany and France, that have similar caps. Some experts have pointed out that banks may go round the law by opening subsidiary microfinance institutions through which they will lend to the ‘risky’ borrowers at higher interest rates outside the regulatory regime.

The challenges associated with interest caps include introduction of fees and charges by banks to compensate for lost income. The World Bank had in a previous research argued that the interest rate caps need to be accompanied by regulation of fees and charges. It also remains to be seen how the new law will affect mobile-based loans.

Banks have offered loans exceeding Sh30 billion through mobile platforms launched a year ago most of which are payable at interest rates of between five and eight per cent a month.

Kenyan banks have been recording high profits even as other sectors struggled, causing a wave of resentment that saw Parliament pass the law.
The bank profits are largely driven by wide interest spreads averaging more than 10 per cent, and which are among the highest among Kenya’s economic peers.

The capping will leave commercial banks with an interest margin of 7.15 percentage points. Banks have warned of job losses as they trim costs to ensure they reward shareholders who have injected huge capital into their operations.

Last year the banks posted an average return on equity of 24 per cent, even as more than 18 listed companies issued profit warnings.
Large banks have been accused of failing to pass the benefits of economies of scale to their customers.

Equity Bank, which has the highest number of customers in the country, posted a return on equity of 47.2 per cent last year, according to CBK data.
Equity chief executive James Mwangi on Tuesday said the lender would cope in a controlled environment by pushing more loans.

The slash in loan prices is expected to fan public appetite for credit which will help banks cover for the loss in margin by disbursing more loans.

“Smaller banks will be more adversely affected as their funding bases are already expensive and they will be unable to lend at premium rates to counter this,” said analysts at Standard Investment Bank.

There are concerns also that investors in the banks listed on the Nairobi Securities Exchange may exit as the lure of high returns is diluted.
Parliamentarians praised the President’s decision, terming it bold.

“Banks need to be more creative. They can still make their profits but with a human soul. Banks should realise those profits have to be made in an environment that is conducive to human souls,” said opposition MP Nicholas Gumbo.

Industry lobby Kenya Bankers Association (KBA) said its members will comply with the law but said it felt an arbitrary rate cap was not in the best interests of most people and businesses.

“The reality is that there is little evidence from other countries that such interventions have helped the majority of citizens, and in a number of countries such laws have been reversed to promote financial inclusion,” the KBA was reported by Reuters as saying in a statement.

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