The World Bank Group has released a paper showing the short-term impact the interest rate caps have had on the Kenyan financial sector since their introduction in September 2016. The paper analyses data from January 2015 to September 2017.
Under the Banking Amendment Act 2016, the interest rate caps were introduced in response to high lending rates in the country and the fact that banks were involved in predatory lending behaviour.
The law, therefore, capped the maximum interest rate banks charged for loans at no more than four per cent of the central bank rate. The law also offers “a floor for the deposit rate held in interest-earning accounts to at least 70 per cent of the base rate.”
The Weaknesses of the Rate Cap Law
According to the paper, Kenya is the only country that has set such a restrictive cap on the financial sector.
The authors of the World Bank paper Mehnaz Safavian and Bilal Zia observe:
“First, the interest rate cap of 14 per cent was set very close to the risk-free rate of public sector borrowing, which at the time was 12-14 per cent on long-term money. Having the nominal interest rate so close to the government risk-free rate meant that banks had little incentive to provide financing to risky market segments. Instead, commercial banks directed their investments to government treasury bills.”
Since the different sizes of banks have different levels of accessing public debt, larger banks could move “to the risk-free space proportionally more than smaller banks” according to the paper.
Secondly, the law had minimal implementation guidelines which resulted in confusion whether financial institutions such as SACCOs, mobile loan providers, and MFIs were supposed to observe the rate caps as well.
The impact of rate caps in other countries like Nicaragua and South Africa in the past has been negative despite their intended purpose to make a positive change. Ergo, the World Bank hypothesizes that the missing clarity with regards to implementation could magnify the negative impact of the caps in Kenya.
According to commercial banks, new borrowers declined from 13 per cent in March 2016 to about six per cent after the caps. Additionally, returns on equity declined, foreign participation in the NSE dropped, new branch expansions slowed down, staff layoffs took place, branches were closed, and banks started lending to less-risky clients.
“Conversations with smaller banks revealed several operational changes due to the caps, such as attempts to tap into the unsecured loan market that the larger banks largely abandoned, reductions in overhead through mobile platform innovations, and forays into alternative sources of revenues such as through money transfers,” the paper reads.
The paper also indicates that there was a drop in the normal portfolio lending after February 2016 while loan values also declined and remained low after October 2016. Non-performing loans (NPLs) increased in February 2016 and remained high after October 2016.
Other impacts of the caps include:
- Decreased lending to SMEs by Tier 1, 2, and 3 banks at the expense of corporate lending which surged 1.8 per cent after the caps. SME lending dropped 1.4 per cent after the caps.
- Personal and household loans increased 2.5 per cent in the post-crisis period (after February 2016) and increased further by 5.3 per cent after the caps.
- Loan growth surged slightly for the energy and water sectors after the caps while it dropped significantly for the Agriculture, Building and Construction, Manufacturing, Tourism, and Trade sectors.
- Increased longer-term loans of over five years of maturity and a decrease in medium-term and short-term loans for Tier 1 banks. Medium-term loans for Tier 2 banks increased substantially while short-term loans for Tier 3 banks increased the most.
- A significant decline in interest-bearing accounts for all tiers of banks.
- Most of the large SACCOs decreased their rates in line with the caps to remain competitive. SACCOs are now turning to mobile solutions to reduce costs and are “looking to non-funded income to supplement reduced funded income.”
- Deposit-taking microfinance institutions (DTMFIs) were also affected by customers expecting lower rates. Therefore, loans were re-priced at 17-18 per cent for SMEs and 22 per cent for microloans. Deposits for DTMFIs also dropped resulting in reduced liquidity and increased offshore borrowing at higher rates.
“While we cannot definitively attribute the slowdown in loan growth and compositional changes among Kenyan banks to the interest caps alone, we certainly do not find any economic attenuation effects that many advocates of the interest rate caps promote. Instead, we find a continued downward trend in loan growth and adverse compositional changes in loan and deposit maturity after the caps,” the paper concludes.