Attempts to cap interest rates keep drawing blanks

Commercial banks in Kenya have been accused of making “too much” profit from their customers.

This argument has elicited debate in the financial services sector. Proposals have been offered on how to stop banks from arbitrarily increasing interest rates.

Kenya does not have a law that imposes a ceiling on interest rates. In 2001, Gem MP Joe Donde introduced a Finance Amendment Bill seeking to create one to that effect. Former President Moi declined to assent to the bill.

A similar attempt was made through the Finance Bill 2011. The Kenya Bankers Association (KBA), a lobby group representing commercial banks in the country, opposed the move, saying it would stifle economic growth and erode the gains made in the financial services sector.

KBA warned that such controls would result in retrenchment of bank staff to reduce personnel costs, which constituted 34 per cent of operating expenses in 2010.

The association explained further that about 28 per cent of banks’ gross profits went to the government in the form of taxes, with 46 per cent being ploughed back or used for expansion activities like opening of new branches. The remaining 26 per cent was paid out to shareholders as dividends.

The controls, continued KBA, would curtail the banks’ capacity to lend by reducing deposit inflows and the amount of funds available for lending.

Borrowers would in turn have no option but to turn to the more costly informal moneylenders, otherwise known as shylocks or loan sharks.

Much more recently in 2012, when the debate on capping interested rates raged again. Interest rates had shot up, and Mr Donde argued that banks were taking home supernormal profits.

From 1906 and in the 1990s, interest rates on loans were capped and banks made reasonable profits, while duly compensating depositors and savers. They began to make abnormal profits, derived from privileged position, from 1993 onwards.

Towards the end of 2011, the Central Bank of Kenya (CBK) raised interest rates considerably in response to a record weakening of the Kenya shilling against the dollar and major world currencies.

The country had somehow enjoyed a relatively fair interest rate regime for a number of years then, with banks charging an average of 13 per cent prior to the interest rate hike at the end of 2011.

Inflation had reached a high of 19.7 per cent in November 2011, while the shilling had weakened against the dollar to a low of Sh107 in October the same year.

CBK’s move to stabilise the shilling and tame inflation raised the benchmark lending rate by 11 percentage points to 18 per cent by December 2011, up from 7 per cent. This sparked interest rate hikes by commercial banks to as much as 30 per cent.

The trend increased the clamour for control of interest rates. An amendment to the Finance Bill in 2012 was proposed to cap interest rates to four per cent above the central bank rate (CBR) and minimum interest rates on deposits pegged at 70 per cent of the CBR.

At the current benchmark lending rate of 8.5 per cent, the spread is at 8.4 per cent against the average lending rate of 16.9 per cent, according to CBK. This is more than double the proposed amendment, pegging the interest rate spread at four per cent.

Some commercial banks are, however, charging as much as 21 per cent or more, depending on the borrower’s risk profile. That puts the spread at 12.5 per cent and makes genuine the argument that banks are making a killing by exploiting borrowers.

In 1991, borrowers were charged an average of 17 per cent, with savings attracting 13 per cent interest rates. Depositors, on the other hand, earned an average of 13 per cent on their money.

Ten years later in 2001, borrowers were charged an average of 19 per cent or 20 per cent. Interest rates earned by savers had fallen drastically to an average of four per cent, with depositors earning an average of six per cent.

In 2003, interest rates on lending declined from 19 per cent in January to 13 per cent in December. Savers, who were earning three per cent at the start of 2003 were now earning a measly 1.3 per cent.

Depositors, on the other hand, were being paid an average of four per cent in January 2003, but the rate dropped to 3 per cent by December the same year.

Gem legislator, Jakoyo Midiwo proposed amendment to the Finance Bill 2012, suggesting that government-owned bodies be authorised to bank only with financial institutions in which the government had a stake.

In turn, they would have to lend money to the public at an interest rate not exceeding four percentage points above CBR.
The amendment was shot down in October 2012 on grounds that it would do more harm to the banking industry than good.

Jakoyo’s prior proposal in 2011 to cap lending rates at four percentage points over the CBR and deposit rates at 70 per cent of CBR had also been defeated in the August house.

Proponents of the amendments have opined that banks could be taking advantage of the weakness in the Finance Act to exploit customers by giving them very little on their savings or deposits and charging exorbitant rates on loans.

This has made it difficult to increase the country’s savings rate relative to other developing countries.

“There’s need for education so that our customers can understand where the banks are coming from. Banks are not just charging for the sake of charging.

There are risks involved. You have to take into account many factors including operating expenses and customers’ risk premiums,” said KCB’s group chief financial officer, Mr Collins Otiwu, in an interview.

Earlier, NIC Capital’s associate director Maurice Opiyo had reckoned that the banking sector should be left to operate in a free market economy where there is competition.