Kenya Banking Sector- A case for short lived rate caps
The interest rate cap debate in 2016 was triggered by high interest spreads (9.5% vs. 6.1% SSA peer average) enjoyed by the Kenyan banks. Predatory lending was evident with commercial banks’ lending at rates as high as 25%. Introducing the rate caps was one of the options the government employed to deal with the high cost of credit in the country. The lending rate was capped at CBR +4% maximum while the deposit rate was capped at 70% of the CBR, as the minimum rate.
Measures taken before rate caps:
Pre–rate caps, the government had initiated measures to bring down the cost of credit as a way of circumnavigating tough regulations such as the rate caps. The initiatives included 1) credit information sharing, 2) introduction of the Kenya Bankers Reference Rate (KBRR) and, 3) establishment of currency centers to help lower transaction costs associated with transportation of cash over long distances across the country. These initiatives had limited success and cost of credit remained high. Today, the KBRR is rendered obsolete by the rate cap law which replaced it as the benchmark rate with the Central Bank Rate (CBR). The earlier strategy was a positive step for our economy though poorly executed hence not meeting its intended purpose.
Solution to the rate caps1) Tiered Cap approaches
• Sector approach employs a variable ‘K’ factor depending on the risk premium levied on every sector with the MSME sector attracting high risk premium.
• The tenure approach employs a variable ‘K’ factor depending on the loan maturity with the longer dated maturities attracting high risk premium .i.e. Mortgage loans.
2) Change of base component means a new base rate other than the CBR. I.e. 3-month moving average for the 364-Day T-bill + K.
3) Repeal means reversal on the rate cap law.
Based on the preference by both the players and the legislators, we rank sector approach as the least preferred by the banks although highly preferred by the legislators with the repeal attracting an opposite reaction.
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