LETTERS: Interest rate caps popular, but it’s a blunt policy tool

Kiambu Town MP Jude Njomo who led the crusade to rein in interest rates recently said “there is a concerted effort by banks, which have formed cartels, to keep off credit from the public, thus blackmailing Parliament into changing a law that protects the ordinary people.”

The law now in place was proposed in 2011 to the opposition of the then economist President Mwai Kibaki.

The MPs had tried twice before to cap rates but their efforts were fruitless. Subsequently, attempts to convince commercial banks to lower their interest rates had been unsuccessful until last year when Parliament unanimously passed the amendment.

President Uhuru Kenyatta later signed the law despite objections from the central bank and the banking industry.

The capping of interest rates has been viewed as a populist move even though the proponents had elucidated it as a cushion to consumers from high interest rates charged by banks at the time.

A study by the Central Bank of Kenya (CBK) points out to harder times for the banking sector and the manifold ripple effects on the Kenyan economy.

Whereas the CBK admits that its study has shown that an interest rates cap is bad for the economy, the law continues to be operational. An increase in non-performing loans is eliciting concern from key financial institutional players.

Small banks are worst affected as they are more reliant on higher risk return loans and sectors and some are finding that their niche business models are no longer viable.

Economists think capping interest rates might solve the high interest rate spreads in the banking sector, but will lead to other challenges such as locking out of SMEs and other “high risk” borrowers from accessing credit as banks will prefer to loan to the government.

READ: Uhuru backs bid to scrap interest rate cap law

Since the capping of interest rates has a tendency to distort the market and cause adverse biases, financial institutions tend to favour their lending to low risk clients which in turn leads to inefficiencies in the financial intermediation process.

Banks in an effort to remain profitable in the midst of interest rate capping have opted for other ventures such as non-funded income as well as cutting their overall operational costs.

These have however made more selective about who they loan to and have lost the incentive to grant long-term loans and finance emerging economic sectors, as the cap means that the rate will be the same as for safer short term loans.

Banks are being asked to lend to private businesses for the same rate they can get for lending to the government which is considered less risky but more profitable. This is a threat to growth in the Kenyan economy which relies heavily on bank lending and private sector credit growth.

To put it simply, one consequence of interest rate caps is that credit flows to safer borrowers rather than to needy but risky businesses or individuals.

Even though the legislation’s main aim was to restrict banking institutions from setting very high interest rates on loans and very low interest rates on deposits, the outcome seems to be different from what was initially intended.

More than a year later the exercise has brought home sobering lessons for the Kenyan economy and the banking sector as a whole.

CBK is, however, contemplating reverting to the free-market regime but in a more disciplined environment.

There is no doubt that when the rate cap was announced one year ago, it was met with a good deal of public approval as uncontrolled interest rates before then had priced local capital out of the reach of the majority of small merchants.

What step Parliament and the Treasury who appear to read from two different scripts will take is yet to be known. But my humble appeal is for reason and sobriety to carry the day.

Gordon Ogayo, Kisumu