Capping of interest rates the wrong medicine

The Central Bank of Kenya building in Nairobi. On July 28, 2016, Parliament passed the Banking Amendment Bill that seeks to cap interest rates at 4 per cent above the Central Bank Rate. PHOTO | FILE | SALATON NJAU

What you need to know:

  • Liberalisation of economies ought to be accompanied by strong resolve and visionary leadership by governments
  • The current high borrowing rates are the effects of liberalisation without order
  • If the Njomo Bill was to become law today, some Tier 2 and all Tier 3 banks would have to pay deposit rates much higher than the lending rates.

On July 28, 2016, Parliament passed the Banking (Amendment) Bill, now famously referred to as the Jude Njomo Bill, that seeks to cap interest rates.

If the Bill becomes law, the maximum lending rates by commercial banks will be 4 per cent above the Central Bank Rate (CBR) which currently stands at 10.5 per cent while the minimum deposit rates will be 70 per cent of CBR.

In today’s world, this would put interest on deposit at 7 per cent and interest on loans at 14.5 per cent.

It is a sad fact that borrowing rates in Kenya are among the highest in the world. It is equally true that the spreads between deposit and lending rates are ridiculously wide.

Both are indefensible as they are unsustainable. In fact they are unacceptable. The status quo cannot hold. We cannot continue holding aloft our bragging rights as a middle income economy while tears from borrowers, especially Small and Medium Enterprises (SMEs), continue to drown our banking halls and banks continue to make super-normal profits. On that I concur with my colleague Njomo.

However, using legislative caps as the remedy is not the solution. It looks good from far but it is actually far from good. History has shown time and time again that once the doors of liberalisation and open markets are opened, trying to close them creates far more destructive and disruptive effects than the problem you would be attempting to solve.

That is why liberalisation of economies ought to be accompanied by strong resolve and visionary leadership by governments and its institutions to mitigate the extremes invariably caused by free market dynamics.

Unfortunately I saw this coming more than two decades ago. When I penned an opinion titled “Liberalisation is not the answer’ (Daily Nation, January 11, 1995), I wrote: “However, it is important that the (liberalisation) measures be taken in a logical order.

INVITE POVERTY

Economic recovery cannot come by accident. It has to be planned. It is high time leaders realised that they will be judged by the foundations they laid for their countries. Lack of foresight will only invite poverty thus creating social strife.”

The current high borrowing rates are the effects of liberalisation without order that I wrote about more than 21 years ago. However, any attempt to go back to 1994 through a single piece of legislation is simplistic. It is simple, direct and wrong.

Why do I say so? Firstly much as we try to hide it, the Kenyan banking sector is a ticking time bomb. Any careless tinkering with policies let alone legislation can trigger a financial crisis of Bohemian proportions.

Today we have six banks referred to as Tier 1 banks that control at least 5 per cent market share individually and 45 per cent collectively. Then there are 16 Tier 2 banks with between 3 to 5 per cent individual market share. Collectively they control 23 per cent of the market.

From this you can see that the top 22 banks control 68 per cent of the market share. Then we have 26 other Tier 3 banks controlling 32 per cent of the market share. This is the real time bomb. On average Tier 1 banks depend on normal customer deposits up to 80 per cent while some Tier 2 and all Tier 3 are funded 75 per cent through term deposits from government agencies and institutional investors.

DEPOSITS ATTACT RATES

These term deposits attract rates of over 18 per cent currently. If the Njomo Bill was to become law today, some Tier 2 and all Tier 3 banks would have to pay deposit rates much higher than the lending rates. This way, half of the banks in Kenya would collapse in a heap like a house of cards. The aftershocks of that eventuality would shake the whole economy and in fact society.

Secondly the Njomo Bill curiously opts for the indicative Central Bank Rate instead of the more actualised Treasury Bills rate which now hovers around 14 per cent. By ignoring the yield curve, it would be impossible to implement even if it becomes law.

Thirdly at the Nairobi Securities Exchange, 70 per cent of the money is from foreign investors. Out of the top 10 stocks at the bourse are six banks. If this Bill is signed into law, you can expect foreign investors to vote with their feet.

The effect of such capital flight will have debilitating effects on the exchange rate and send the Kenya shilling to the Intensive Care Unit.

Fourthly, banks will always create a way to recoup their losses. They will just raise transaction fees to shore up their non-funded income.

The writer is MP for Gatundu South. He has previously worked for major banks locally and internationally [email protected]