Banks face refunds worth billions of shillings for illegal loan charges after courts ruled that lenders cannot alter interest rates on credit without formal approval from the Treasury Cabinet Secretary.
The High Court last week rejected a petition from the bankers’ lobby—the Kenya Bankers Association (KBA)—to declare Section 44 of the Banking Act unconstitutional.
Section 44 of the Banking Act states that “no institution shall increase its rate of banking or other charges except with the prior approval of the minister”.
The lobby moved to the High Court following two separate decisions where the judges ruled that Stanbic Bank and Spire Bank breached the law after changing their lending rates without approval from the Treasury.
Stanbic was ordered to refund a customer more than Sh10 million, and Spire was compelled to reduce an outstanding loan balance in judgments that sent shockwaves through the banking sector, sparking fears of an avalanche of suits.
In the banker’s latest push for the judge’s mercy, the KBA also lost its bid to stop enforcement of Section 44, paving the way for borrowers to petition courts for a refund of extra loan charges that failed to get approval from the Treasury Cabinet Secretary.
“Section 44 neither usurps nor interferes with CBK’s constitutional mandate under Article 231(2) & (3). No inconsistency with the Constitution has been demonstrated,” said the High Court.
Banks had been receiving approvals from the Central Bank of Kenya (CBK) before increasing lending rates on the back of a May 2006 legal notice, which then Minister for Finance Amos Kimunya officially delegated the consent powers to the Central Bank governor.
The Stanbic and Spire Bank judgments successfully challenged the 19-year-old notice or the so-called Legal Notice No. 35 of 2006, with courts siding with customers that a Cabinet Secretary “can only donate his authority but not responsibility”.
The Supreme Court of Kenya, in the Stanbic suit and the High Court over Spire Bank, separately ruled that the legal notice did not absolve the Treasury CS from legal responsibility.
The KBA had argued that Section 44 violated constitutional provisions safeguarding the Central Bank of Kenya’s (CBK) independence in monetary policy formulation.
In their petition, the lobby group sought two key declarations: first, that the section was inconsistent with Article 231(2) and (3) of the Constitution, and second, an order restraining its enforcement against member banks.
They reckoned that requiring executive approval for rate adjustments undermined CBK’s autonomy in monetary policy.
They claimed that interest rate adjustments are a key tool of monetary policy and that requiring approval from the Executive arm of government undermined the Central Bank’s autonomy under Article 231 of the Constitution.
However, the judge said there exists a distinction between monetary policy—a CBK mandate—and commercial lending practices, which remain subject to parliamentary regulation.
“I am persuaded that section 44 neither prescribes the monetary-policy rate nor restricts the CBK’s authority to formulate or implement monetary policy. It instead regulates how licensed institutions adjust their commercial lending terms,” the judge ruled.
“Its purpose is not to give the Cabinet Secretary authority over monetary policy but to regulate the commercial behaviour of banking institutions in relation to their customers. Section 44, therefore, falls squarely within the realm of consumer and market regulation, not monetary policy,” he added.
Mr Kimunya had, in the May 2006 notice, said he had delegated the powers over interest rate variation to the CBK governor “for the time being,” requiring the central bank to only update him after every three months on changes in borrowing cost and other charges.
The courts ruled that the variation of loan interest terms without the involvement of the CS was illegal and unenforceable.
This risks opening the legal floodgates to suits against banks over loan terms, as high lending rates have partly contributed to loan defaults.
Lending surges at their fastest rate in the two years to November 2024, driving the defaults and slowing borrowing to a multi-year low.
The rates surged from an average of 12.36 percent in November 2022 to 17.22 percent in the same month last year, as banks revised borrowing costs upward without the Treasury CS’s approval.
The rates have receded to 14.9 percent in line with cuts on the benchmark rate and the CBK threats.
The Treasury, the ministry that houses CBK, has, over the years, largely taken a back seat on matters of interest rates.
Banks have routinely sought clearance from the regulator when altering loan terms, and the Treasury rarely intervened.
The Treasury’s stance has persisted for nearly two decades, with the position of courts thrusting it back into a central regulatory role it had informally relinquished.
Mr Kimunya’s legal notice had been used over the years by CBK to receive and approve banks’ applications to vary interest rates.
However, this was first put to the test by Santowels Limited, a Stanbic Bank of Kenya customer who had taken out several loans between 1993 and 1997.
Santowels, a sanitary towel manufacturer, fell out with Stanbic over varying interest rates to levels it felt were unjustified.
Court papers show that in 2002, the company paid the outstanding amount and closed its accounts with Stanbic.
However, it moved to court the following year, arguing that the bank unilaterally varied interest rates without seeking the Treasury’s approval and charged it Sh17.25 million in extra interest.
The suit escalated from High Court to the Court of Appeal and finally the Supreme Court, which agreed with the Court of Appeal that interest rates on loans and facilities advanced by banks are subject to regulation under Section 44 of the Banking Act, requiring prior approval from the Cabinet Secretary.
The Stanbic case was also cited in the High Court judgment of July, where Spire Bank was found to have varied the interest rate on a customer’s loan to 32.5 percent from 28.5 percent without approval from the Treasury.
Spire was ordered to recalculate the loan using the correct rate and issue the customer with an updated outstanding balance.
