Kenya’s finance minister, Henry Rotich, surprised the country’s banking industry in June 2018 when he announced as part of his budget that the government intended to scrap the interest rate caps imposed 22 months before.
The banks welcomed the U-turn because they claimed the caps were hindering credit growth and access. Section 33B of the 2016 Banking Amendment Act (BAA) capped the rate at which banks in Kenya could charge interest to 4% above the Central Bank of Kenya (CBK) rate. The CBK rate has remained stable at 9.5% since March this year.
The law also set the minimum interest a commercial bank depositor can earn at 70% of the CBK rate. The rate caps were introduced to end the practice of banks charging high interest rates for loans and to encourage Kenyans to save. However, they had the unintended consequence of causing interest earnings from loans to dip and commercial banks’ loan books to shrink. The banks have sought to mitigate these losses by aligning their businesses towards non-interest income, including fees and commissions, and government securities, according to Dannington Murage, analyst at Ecobank Capital in Kenya.
“Historically banks’ earnings came mainly from loan activity, but after the interest rate cap came into effect, banks were unable to accurately price their risks… Therefore, the banks slowed down their lending activity,” says Murage. “Banks have ramped up their investment in government securities significantly in order to adapt to the current regulatory climate.”
Investment in securities has reached unprecedented levels, growing by 6.1% in the first quarter of this year to KSh1.09 trillion ($10.8bn), despite the fact that yields had been weakening in 2017. The continued investment in government securities in this environment indicates the high levels of risk aversion by banks in the face of the interest rate caps, according to Murage. Hardest hit by the rate cap are the small- and medium-sized banks that makeup 20% of the banking market share in the country.
These financial institutions are particularly vulnerable to industry shocks and have seen their earnings slashed. However, digital lenders offering micro-credit via mobile devices, such as KCB Bank Kenya and Commercial Bank of Africa (CBA), have proven to be resilient in the current difficult climate, says Murage. The micro-loans are between KSh1,000 and KSh50,000.
Despite the success of the micro-loan industry, the main banking sector continues to feel the pressure of the rate cap. However, the government faces an uphill task in repealing Section 33B, with some members in the ruling Jubilee Party reluctant to see the law changed. Lawmakers are currently reviewing the repeal, with any changes being made in the fourth quarter at the earliest. While the banking sector awaits parliament’s decision, there is hope that the government U-turn will provide relief for the industry. However, that relief will likely be short-lived because of new taxes being proposed by the government.
Robin Hood tax
During his budget announcement, the finance minister also revealed the government’s plans for a so-called “Robin Hood” tax – which would impose a duty of 0.05% on any transaction worth KSh500,000 or above transferred via banks and financial institutions – to help fund record levels of government spending. The imposition of the tax on 1 July caused consternation in the banking sector. CBK data shows that the average daily interbank volumes fell week-on-week by KSh14.8m to KSh11.2m in the first week of July.
On 12 July, Jeremy Awori, CEO at Barclays Bank Kenya, warned that the measure was reducing liquidity levels in the financial services sector because banks were keeping hold of money to cover extra costs. “Banks are incentivised to conserve their own liquidity,” he told reporters. “I’m not going to be actively lending to this bank, paying a tax, and at the same time borrowing from this bank if I have a mismatch. I’ll just keep the money.”
The banks – acting through their trade body, the Kenya Bankers Association (KBA) – successfully lobbied Kenya’s High Court to temporarily suspend the tax just weeks after it had been implemented. They claimed that there were “several areas where it would be impractical to implement the tax”. The court will hear the association’s arguments in September 2018.
The government has also put forward the 2018 Financial Markets Conduct Bill which seeks to reshape the regulatory framework of the retail credit market. The bill would create four new regulatory bodies – the Financial Markets Conduct Authority, the Financial Sector Ombudsman, the Conduct Compensation Fund Board, and the Financial Services Tribunal.
These government organisations would be tasked with “protecting customers, promoting competition and development in the financial sector, and supporting the government’s economic policy”. However, the banks have warned that the bill will weaken the CBK, damage the country’s banking sector and scare investors away.
Despite the warnings, the government seems determined to enact the various changes to the banking sector. This is leading to great uncertainty which could ultimately hurt the wider economy. “Excessive control and regulation does not help markets and it’s not going to help the industry,” claims Awori.
*This article was corrected on 6 August 2018.