What the new interest rates law means for borrowers, depositors

On Wednesday last week, President Uhuru Kenyatta assented to the Banking Amendment Bill 2015 which capped interest rates at no more than 4 per cent above the Central Bank of Kenya (CBK) reference rate.

With the CBK’s reference rate standing at 10.5 per cent, the new law effectively means interest rates are set to fall from highs of 18.3 per cent and 24 per cent for unsecured personal loans, to 14.5 per cent.

The new law has come after a protracted battle to cap interest rates that began during President Moi’s era.

Kenyan lenders have been maintaining high interest rates despite the cost of borrowing declining in the region. Overall average lending rates in the Sub-Saharan region have been on a downward trend since 2005 when they were at 26.3 per cent. By 2015, regional lending rates had fallen to lows of 16.9 per cent.

However, in Kenya, banks have been accused of notoriously failing to lower the cost of loans, with some borrowers paying over 24 per cent in interests.

Head of Investax Capital Ltd Ndindi Nyoro says the new rule was fuelled by an overall corporate greed.

“Kenya is becoming an economy of controlled prices because our companies prefer to operate as cartels instead of giving way to full capitalistic tendencies,” he says. His sentiments are echoed by investment analyst and financial columnist George Bodo. “The signing was also inspired by the general public’s mistreatment by banks. It is incumbent upon banks to end the predatory relationship between them and the public,” he said.

So what is the impact of the new law on borrowers?

If you took a Sh1 million unsecured personal loan at 24 per cent interest rate for five years prior to the signing of the new law, your monthly repayments would be Sh28,767. This means that at the end of the loan repayment, you would pay a total interest of Sh726,020.

However, with the new law and a total percentage of 14.5 per cent, the same loan will attract a monthly repayment of Sh23,528 and a total loan repayment interest of Sh411,697. This means that the new law would save you Sh314,323.

Banks have also been accused of arbitrarily changing the loan rates in the middle of the payment, making it hard for borrowers to precisely know how much they pay for a loan.

Mr Kwame Otieno, a financial columnist and CEO of Institute of Economic Affairs, now says borrowers will now be able to predict the cost they may be charged.

“It will now be possible to predict the maximum interest on a loan to be provided using the base rate. For example, if you borrow Sh50,000 and the base rate is set at 10 per cent, then the total interest to be paid within a year will not exceed Sh7,000,” he says.

Additionally, depositors will start getting 7.35 per cent on deposits after the law enforced interests on deposits to be 70 per cent of the Central Bank Rate (CBR) benchmark of 10.5 per cent.

Despite the fact that new law will be a boon to borrowers, bankers and a section of analysts say it is a time bomb that will be a huge blow to the economy sooner rather than later.

A financial report by Sterling Capital Ltd, says despite the good intentions, the capping of interest rates may actually hurt low-income earners. “Ceilings on interest rates often tend to trigger credit rationing and reducing of transparency in the total cost of loan,” the report says. “If the ceilings are too low, banks will find difficulty in recovering costs. This could lead to slowed growth rates.”

This is echoed by a report on the capping of interest rates by Cytonn Investments. The report says banks might introduce new and lawful fees required to access loans, and the total cost will go back to what is commercially viable.

“Law pricing might be less transparent henceforth, given the new types of lawful fees the banks are bound to introduce,” noted the report.

In the same vein, banks see this as a measure that will lock out thousands of borrowers while giving a goldmine to informal and unregulated lenders such as shylocks.

The Kenya Bankers Association (KBA), said personal loan applications of Sh200,000 and below will be denied. “The immediate impact is that more than Sh18 billion in personal loans applications for amounts below Sh200,000 will be quashed,” said KBA in a statement.

Existing loans

To begin with, to KBA, the current existing loan terms and rates will continue to prevail until the new law is gazetted and rules on how it will be implemented are published. “In the interim, the existing loan and deposit account terms will apply,” KBA said in a statement.

The lobby says the law does not specify the base lending rate for determining the maximum 4 per cent lending cost.
“It has been assumed it is the Central Bank Rate (CBR) but CBK may opt to use Kenya Banks Reference Rate (KBRR) or CBR or it may create a new rate,” said KBA chief executive Habil Olaka.

If the Central Bank Rate is used, the maximum lending rate will be 14.5 per cent. However, if the KBRR is used, this maximum cost will fall to 12.9 per cent. Currently, the KBRR is set at 8.9 per cent.

Additionally, according to KBA, banks are awaiting communication from the government on whether those with existing loans will enjoy the lowered interests.

Bank investors

Among those who have been affected by the new law are shareholders of listed banks on the Nairobi Securities Exchange where the new law pounced first. On the first day after the signing of the Bill into law, banking stocks on NSE suffered a blood bath that saw all of them lose a combined Sh47 billion in market value.

The NSE All Share Index crumbled by 5.01 per cent to 139.14 points while the NSE 20 Share Index fell by 4.41 per cent to 3,309.76 points. On Friday, the free fall continued with banking stocks losing by 9 to 11 per cent.

“The effects on NSE were vicious. I find it difficult for the banks to offer lashings and lashings of credit at 14.5 per cent,” said Mr Aly Khan Satchu, a financial markets researcher and the head of Rich Management.

However, there are those who see this as an opportunity to take position in fundamentally strong banking stocks at a discount. For instance, the most profitable banks in the country, Equity Bank and KCB were trading at a discounted price of Sh29.50 and Sh27 per share respectively.

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