Kenyan banks Thursday got critical support in their war against interest rate controls after the International Monetary Fund (IMF) asked the Treasury to remove the caps that came into force last September.
The Kenya Bankers Association (KBA) chief executive, Habil Olaka, said capping the cost of loans had sapped energy from banks, slowing down growth as fourth quarter 2016 financial results expected to released next month will show.
The IMF said in its note on Kenya that the controls pose a risk to financial stability in East Africa’s biggest economy and had slowed Kenya’s leadership in the journey of financial inclusion.
IMF deputy managing director Tao Zhang said in a statement that the rate caps were likely to reduce access to credit and weigh down economic growth.
Parliament passed the law capping interest rates last August despite a spirited attempt by banks, the Treasury and Central Bank of Kenya to stop it.
The IMF had also warned against the caps but this is the first time the fund has explicitly called for its removal.
Survival of small banks
“The macroeconomic outlook is overall positive, including robust growth and reduced external imbalances. However, interest rate controls are likely to reduce access to credit, weighing on growth,” the Washington-based global financial institution said, adding that interest controls had also complicated monetary policy and threatened the survival of small banks.
The IMF said that although the adverse effects of the controls are manageable in the near term they pose a risk to Kenya’s financial stability if allowed to persist in the long term.
“Therefore, it is essential to remove these controls, while taking steps to prevent predatory lending and increase competition and transparency of the banking sector,” said Mr Tao.
The note was written after the IMF’s executive board completed the first review of Kenya’s performance under the standby support programme valued at $1.5 billion (Sh150 billion).
Banks have maintained their opposition to the law, which limits interest on loans at four percentage points above the Central Bank Rate (CBR).
Mr Olaka said banks were optimistic that the law will be revised once its full effect becomes clear.
“When the impact on the economy becomes clear, then there will be a compelling reason to show all stakeholders that this is not just a banking sector issue but one that affects the wider economy,” he said.
Fourth quarter financial results for banks are expected to show that the interest rate caps had caused a shift in credit from critical yet risky sectors of the economy to the less productive sectors.
“That would be the time for the political side to pick it up and see that they may need to do something for the good of the economy,” said Mr Olaka.
The IMF said the caps had had a negative effect on transmission of monetary policy, implying that the caps had delayed the establishment of an interest rate corridor — setting the upper and lower limits of the interbank rate aligned to the CBR that would alleviate liquidity problems for smaller banks.
Senior Treasury officials did not respond to queries on the IMF note, with calls to the Cabinet Secretary, Henry Rotich, and Principal Secretary Kamau Thugge going unanswered.
Data still insufficient
Financial analysts, however, said that there is unlikely to be much agreement between those opposing the rate cap and its supporters, especially at this stage when banking sector data is still not sufficient to establish the impact of the new law.
“There remains strong divergence between proponents for and against the interest rate controls — a good case in point being the proposed introduction of the Banking (Amendment) Bill 2017 seeking to further tighten the interest rate controls rules,” said Standard Investment Bank in a brief on the IMF statement.
“While private sector credit is currently at a multi-year low, it is still not clear if the dip is solely an outcome of credit rationing by commercial banks due to restrictions imposed when pricing risk or it is being driven by conservatism due to high industry non-performing loan,” the investment bank said in a note to its clients.
Kiambu Town MP Jude Njomo, who authored the legislation, maintained that Parliament was right to cap the rates, judging by its impact on ordinary Kenyans.
This indicates that any attempt to reverse the rate cap is likely to run into strong political headwinds from Parliament, especially with a General Election looming.
“The Kenya National Assembly does not consult the IMF when making laws. They (IMF) may not be happy with the capping, but we can see that Kenyans are happy with it,” Mr Njomo said.
There are already indications that Parliament is more likely to tighten the interest rate cap rather than relax it, should the proposed Amendment Bill (2017) see the light of day.
If passed, banks will, among other things, be required to include all charges related to a loan within the cost of interest charged, which would hit their non-interest earnings.