After going through all the legislative stages, the Banking Amendment Bill 2015 now awaits President Kenyatta’s assent or dissent. Many economists, policy analysts and concerned citizens have expressed their varying opinions on this serious policy matter, either in the affirmative or negative.
There is no doubt that the institutionalization of the usury laws or simply the capping/controlling of interest rates within the economy elicits emotions and passions. The subjection of interest rates to legal control(s) is a controversial issue, always debated either with doses of naïveté or with the showmanship of great scholarly discourse on the other side of the continuum.
Two schools of thought are prevalent in this particular economic disquisition. The first school of thought advocates for the capping of the interest rates in order to enable the borrowers to access credit/loans at affordable and reasonable interest rates. The second school of thought is largely diametric to the first one and it argues that controlling interest rates significantly reduces the availability of credit in the market.
For proper understanding, it is vitally important that one is aware of the different interest rate capping regimes. The first regime is known as the interest rate controls where the central bank is tasked with the mandate of instituting a ceiling of the interest rates in the economy. The second regime is known as the usury laws whereby a specific organ of the government is supposed to control the interest rates. In most cases, the organ that normally plays this role is Parliament through the formulation of the respective pieces of legislation. The third regime is known as the de facto ceiling in which the controls are put in place by way of agreement, that is, without formal legislation. This regime is usually as a result of pressure from the civil society or through political pressure.
Kenya’s case, therefore, can be classified as falling under the usury laws regime. Fast forward, the rationale for capping of the interest rates ought to be examined. The rationale, however, is kindred to the two schools of thought. The general agreement is that the interest rate controls are necessary for the following main reasons: protect consumers from excessive interest rates, increase access to finance, make loans to be more affordable.
The key precept underlying the enactment of this policy is to keep in check the financial institutions that charge very high interest rates to the borrowers. In due course, there is a general consensus that capping of interest rates should be based on the advent and prevalence of market failure in the whole economy or within certain sectors of the economy.
The credit market just like any other market (commodity market) can experience market failure. Market failure, in simple terms, is an economic state in which the forces of demand and supply are skewed; in other words, the forces are distorted. Market failure in the credit market implies that the market is unable to “freely” lower the level of the interest rates. The Kenyan credit market has been unable to effectively bring down the interest rates and to an extent, this can be deemed as a form of market failure.
But does the Banking Amendment Bill 2015 take into consideration the fundamentals that have contributed to the relatively higher interest rates in the state? In my opinion it doesn’t because it overrides the two main objectives of controlling interest rates at least according to the global best practice; targeting a definite sector or industry of the economy and being a short-term policy intervention.
This legislation seeking to curb the interest rates is amorphous because it doesn’t target a specific sector/industry of the economy and furthermore it is vague in terms of the time span in which the capping will be effected. It would have been economically sound if the capping of the interest rates would have targeted, for instance, to improve the accessibility of loans for people involved in agricultural activities or even the jua kali sector because they are the largest contributors of employment in the economy.
The problem with majority of the Members of Parliament is that they don’t subject most of the legislative discussions and legislations to logic and rationality. This leads to the passage of populist legislations in the name of protecting the citizens.
Primary Causes of High Interest Rates in Kenya
There are two main causes of the high interest rates in the state; the first one is the oligopolistic nature of the credit market and the second reason is the voracious appetite for borrowing fashioned by the current administration. Kenya’s credit market is perceived as competitive, but just how competitive is it? Out of the forty two commercial banks in the economy, six of them (deemed to be the largest) control 52.4% of the credit market. This implies that the remaining thirty six banks control the remaining 47.6%, with an average share of 1.32% per bank. This is utterly ridiculous. The situation is not rosy for the microfinance institutions. According to statistics by the Central Bank of Kenya, three microfinance institutions control about 93% of the respective market share.
The determination of the interest rates in the market, in view of the above cases, will be subject to the behavior of the dominant financial institutions. The habit of the ruling administration to engage in wanton borrowing is also a significant cause because the government can borrow at any level of interest rate.
Effects of Interest Rate Controls
If the Banking Amendment Bill 2015 will be assented by the president, then the following effects are likely to be witnessed, or otherwise experienced in the economy. First, the access to financial resources by a certain segment of borrowers will be limited as the financial institutions may: establish rigid credit terms, raise the minimum size of the loans, increase and even add other non-interest fees and charges. The borrowers who will be highly affected include the first time borrowers and low-income borrowers. All these measures will be put in place by the financial institutions because of the need to maintain similar profit margins.
Secondly, the overall cost of credit (loans) for all the potential borrowers will go up owing to the expected terms to be instituted by the financial institutions. Thirdly, capping of the interest rates may occasion some of the financial institutions to withdraw from advancing credit to certain areas or sectors due to the imminent high operation costs. Another effect will be reduced investments in new markets by these entities. The other consequence will be the rise of more informal lenders (Shylocks) with the intention of filling the financial vacuum created.
The bottom line, irrespective of the individual effects, will slacken the pace and rate of financial inclusion in Kenya’s economy.
To address the matter of effectively lowering the interest rates, other policies other than capping of interest rates should be formulated and implemented. The first policy must obviously address the issue of competition. Kenya’s credit market needs healthy competition and this can be made possible through the amalgamation and consolidation of the small banks and the other financial institutions. We can have very few but very competitive financial institutions. The Central Bank of Kenya under the stewardship of Dr. Patrick Njoroge is putting in place measures to facilitate healthy competition and it may take a number of years.
The government should also significantly reduce on the rate at which it has been borrowing from the domestic market. There is need therefore for the Treasury chiefs to effect fiscal policies anchored on absolute austerity so as to create a conducive economic environment with regards to the level of interest rates.
Formulation of laws to control interest rates in the whole economy is illogical because such capping is supposed to spur growth and development in a certain sector/industry. In Kenya’s case, the Banking Amendment Bill 2015 doesn’t address any specific sector and President Kenyatta needs to dissent it. I believe that if Kenya’s credit market will be very competitive and free from control by a few large banks then relatively low interest rates will definitely be a reality in addition to the implementation fiscal measures that promote low levels of government borrowing.