How high bank interest rates bring down business empires

What was Kenneth Matiba’s flagship Jadini Beach Hotel lies in ruins, with the jungle taking over from where a ballooning loan pushed him.

The fall of Matiba’s Alliance Group of Hotels, as well as his Hillcrest Schools, remain a painful reminder of what happens in a regime with high interest rates.

Jadini was splendid: 60 acres of land and a beachfront of 300 metres. It was sold by Barclays Bank of Kenya for Sh900 million. Barclays also sold off the schools to recover a defaulted loan that had grown to Sh620 million.

The fall of the Matiba empire is not only linked to politics but also a pileup of bad debts.

When Parliament passed a Bill to cap interest rates, it was acting out of the frustration many Kenyans had faced when banks arbitrarily increased the rates. Untamed interest rates have seen banks earn billions of shillings in profits, even when other sectors of the economy are faltering.

Now that hurdle is at the doorstep of President Uhuru Kenyatta, who promised in his 2013 presidential campaigns to bring down interest rates. An excuse for the high, seemingly unregulated runaway interest rates was that the Judiciary and the Executive have failed to protect borrowers when called upon to do so.

Previous attempts to cap interest rates have faltered. In 2000, President Daniel arap Moi rejected the "Donde Bill", which sought to tame the interest rates. He argued in a memorandum to Parliament that state control of interest rates would be against the spirit of the liberalisation policy.

While President Mwai Kibaki had supported the Bill, asking the Moi regime not to be intimidated by commercial banks, he also failed to tame the banks when he took office and they snubbed his order to lower interest rates.

The Judiciary has not been of help either. While some Kenyans had their properties auctioned in silence others tried to fight through the courts. A few were victorious but many lost. In most cases, courts ruled that the Banking Act gave banks the right to increase rates without informing the borrower—or without approval of the Finance minister.

ENGLISH LAW

The courts have always relied on an English law principle that no amount of dispute as to the sums of money owed by an applicant can permit the courts to stop the sale of a property. This has given banks the right to auction property even when there was a dispute on the amount owed.

“Provided that an applicant is indebted to the respondent in whatever way…court cannot stand in its way,” ruled Justice Leonard Njagi in a case pitting businessman John Kanya against Barclays.

Before taking loans, customers sign a letter of offer stipulating the interest rates but usually fail to read the fine words in the deed of agreement, which normally states that “the borrower shall pay commission, interest, fees and charges to date of payment at the rate and upon the terms from time to time agreed with the bank or, if not so agreed, at such rate or rates (not exceeding any maximum permitted by law and subject to a minimum rate of six per cent per annum over the base rate of the bank from time to time) as the bank may, in its absolute discretion, determine”.

It is this hidden clause that has left many borrowers at the mercy of banks, which have had the support of the courts. In 2006, Justice Anyara Emukule, in the case of Daniel Mugambi versus Housing Finance, said it was “uncertain” whether or not the provisions of Section 44 of the Banking Act limit the interest rates chargeable by banks and other institutions. As a follow-up to that view, Justice Patrick J Kamau held that in the said section there was “no specific mention of interest (rates)” and found that there was no contravention of the Banking Act when the bank varied the interest rates without approval from the minister. Most businessmen had gone to court on account that banks increased the rates without approval from the Finance minister.

It was in the case of Muiruri Gachoka, a Thika farmer and father of activist Tony Gachoka, that the Court of Appeal held that banks had misused the law to arbitrarily increase interest rates. They said: “We have found in the above discussion that there was no evidence that the interest rate charged by the respondent was in accordance with Section 44 of the Banking Act. We have found that it was manifestly excessive, and, in the words of the trial judge, morally wrong. We have further expressed the view that the clause relied on to charge the interest that led to this exhorbitant indebtedness was not only unconscionable and without notice to the appellant but was bad for failure to accord with the relevant provisions of the law. In addition, we have found that the bank owed a statutory and fiduciary duty of care to the appellant and the deceased’s estate”.

HAD INCREASED

In the Gachoka case, the bank had increased the interest rate from 14 per cent to 45 per cent.

While individuals fought within the court corridors, attempts to cap the interest rates charged by banks have faltered many a times. With the recent passing of the Bill that seeks to do so, Kenya Bankers Association has asked President Uhuru Kenyatta not to assent into it.

Mr Habil Olaka, chief executive officer of KBA, said the industry body opposed the amendments since they would have deep ramifications on the economy.

“One of the things that will be a consequence of the proposal...means...the bank will have to assess the risk profile of the borrowers, and it is only those borrowers who fit within that risk profile that is legislated in the law that will then be accessible to credit,” Mr Olaka told a news conference.

His deputy, Mr John Gachora, added that borrowers could resort to foreign currency-denominated loans, which could lead to a weakening of the shilling.

The Central Bank of Kenya Governor, Dr Patrick Njoroge, has also opposed the Bill saying capping of interest rates would lead to inefficiencies and promote informal lending channels. He nonetheless agrees that Kenya’s lending rates are too high.

The Bill was sponsored by Kiambu Town MP Jude Njomo, who says its assent into law would promote business. According to the Bill, banks will charge at most four per cent of the base rate set by CBK. At the moment, banks charge as much as 25 per cent interest, making Kenyans unable to afford loans and mortgages.

The current base rate is set at 11 per cent, which means that Kenyans could at most pay only 15 per cent interest rates.

Should the Bill become law, deposits held in interest-earning accounts would earn interest at 7.3 per cent at the minimum.

Will the President sign the Bill into law, on its third attempt?