The interest rate cap, imposed by the Central Bank of Kenya in September 2016, was finally removed in November 2019, much to the relief of bankers. What has been the effect on banks and their customers?
It took years of lobbying and protestation by Kenya’s banks and its customers – and not so subtle pressure from the IMF – to persuade Kenya’s parliament to repeal the cap on interest rates imposed since 2016.
The cap, which set interest rates chargeable by banks at 4%, equal to the base rate set by the Central Bank of Kenya (CBK), was intended to address the issue of the affordability of credit for small enterprises and working people, as they had complained for years that high interest rates had locked them out of mainstream bank credit. The initial law to cap interest rates, which won wide popularity, was championed by President Uhuru Kenyatta but in a major volte face, he refused to endorse a renewal of the bill when it came up in November and despite strong support for it, it failed to gain the majority required for the law to remain on the statute books.
Defending his decision, Kenyatta said that while the intentions were good, in practice, the cap had actually reduced credit to the private sector, damaged growth and weakened the effectiveness of monetary policy.
According to analysts, SMEs were reportedly denied loans worth about Kshs300bn ($2.97bn), about 1% of GDP, during the period. Furthermore, credit extension to SMEs as a percentage of total bank loans fell to 15% in 2019, from about 25% before the cap was instituted.
If any further persuasion was needed, the IMF provided it by simple arm-twisting. It told the government that if it wanted an extension of its standby credit, it would have to ditch the cap. With the cap now scrapped, Kenyan banks, and indeed the economy, are expected to perform better in 2020. How well, though?
Stronger earnings and loan growth
Charles Robertson, global chief economist and head of macro strategy at Renaissance Capital, tells African Banker “the effects of the rate cap repeal will start to show up in 2020 consumption and investment data and definitely should support growth – and help to compensate for a tighter government budget.”
George Mutua, managing director and chief representative officer, Kenya & East Africa at Société Générale, agrees. “Kenya’s GDP growth, projected between 5.5 to 6.0% in 2020, would be driven mainly by increased credit growth, after the removal of the interest rate cap, as banks lend more to the private sector.”
However, “banks will need to monitor non-performing loans (NPLs) closely to ensure they don’t breach acceptable thresholds on the back of this increased lending”, Mutua adds. In December 2019, Fitch Ratings announced a positive 2020 outlook for Kenya’s banking sector, an upgrade from stable in 2019. The repeal of the loan rate cap in November 2019 is a major reason why, as Fitch believes it “will allow banks to take control of their pricing policy and underwrite new business at rates more in line with borrowers’ risk profile.”
Fitch also sees “improving credit conditions” enabling “banks to execute growth strategies.” In fact, Fitch expects over 10% loan growth in 2020, a continuation of the recovery in 2019.
“Kenyan banks received a huge boost in November when the lending rate cap was repealed by the government,” Mahin Dissanayake, senior director of Europe, the Middle East & Africa (EMEA) at Fitch Ratings, explains further to African Banker. “We believe it will increase earnings and profitability on the back of loan repricing and stronger loan growth, with credit flowing back to key sectors like micro, small and medium enterprises and consumers.”
In the same vein Constantinos Kypreos, senior vice president, financial institutions at Moody’s, tells African Banker “removing the rate cap no longer constrains lending as banks are able to better price their risks without a rate cap. This will mean increased lending to segments of the economy that have had subdued growth and access to credit, primarily small and midsize enterprises.”
Kypreos tells African Banker, does not expect lending rates or profitability to return to early 2016 levels. Banks’ return on assets declined to 3.4% in 2018 from 3.6% in 2017 and 4.0% in 2016.
Fitch’s Dissanayake shares a similar view. “Margins and earnings are unlikely to return to pre-cap levels. This is partly because banks have indicated that they might limit any increase in the cost of credit to customers and partly because the policy rate is 1.5% points lower than the pre-cap level.”
But not everybody is pleased that the cap has been dropped. There is a worry that banks, freed from the rate constraint, will seek to make up for lost time and profits, jacking up interest rates to the prohibitive 24 to 32% levels before the curb.
The Standard newspaper says: “Repealing this law therefore may have enormous impact on businesses. The increased interest rates will eat into these businesses’ revenues and thus affect their short-term and long-term development goals. Such a scenario would be so serious that some businesses may have to implement some cost-cutting measures such as laying-off staff to be able to service loans.”
Samual Baraka, who sells spare parts in Nairobi agrees with the comments. “The cap allowed us to borrow at a fair rate from banks to carry out daily business. This allowed me to expand my operations and take on more people. Now I worry that the banks will revert to the high rates we had before. How will we be able to afford to borrow? It will lead to many small businesses closing down and laying off people.”
Unemployment is already high in the country and the ranks of the jobless are increasing by the day as more youths join the labour force. The rate cap was actually a device to try and stimulate the SME sector and thus create more employment. There is evidence that this worked and the fear is that the removal of the cap will create a slump at a time when making a living is particularly difficult.
Banks have argued that the cap dissuaded them from lending to the more risky business elements because of the fear of loan defaults and that they need a higher margin to cover the risk. However, few believe that banks will increase their lending to SMEs now that there is no cap, despite the presence of the Credit Reference Bureaux, which provide an assessment of borrower creditworthiness.
It will be interesting to see if having been released from the rate cap, the bankers fulfil their pledge to roll out more loans and boost the economy or if the vital SME sector gets further squeezed.