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AfricaMay 28 2012

Kenyan banks swerve interest rate cap

Most African governments are keen to liberalise their financial sectors. Kenya’s would have sent a clear signal in the opposite direction had MPs passed proposals to cap interest rates earlier in 2012. For now, such a move seems off the table. But looming elections could change that.
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What is it?

Kenyan banks have often been on the receiving end of calls from politicians to lower their interest rates and make life easier for consumers. It was only in the 1990s that the east African country’s interest rate regime was liberalised, while there was an attempt 10 years ago, through the so-called Donde Bill, to control rates. 

But, having thought such restrictions were a thing of the past, Kenya’s banks came under renewed pressure earlier in 2012 when a group of MPs proposed amendments to the finance bill, which needs to be passed for the government to implement its budget. The legislators wanted lending rates capped at 400 basis points above the central bank’s main interest rate and deposit rates to be a minimum of 70% of that. 

Why now?

Banker-bashing is hardly unique to the West, as this example demonstrates. Most analysts say that the proposals were designed to win favour from Kenyan voters ahead of elections scheduled for December 2012 or March 2013. Banks were an easy target, given their booming profits and the fact that several enjoy hefty net interest margins of 10%. 

But the trigger for the proposed amendments was rocketing inflation and interest rates in 2011. Thanks to sharply rising food and oil prices in early 2011, Kenya’s central bank – which was widely criticised for reacting far too slowly – put up its key interest rate from 6.25% to 18% between August and December. Banks almost immediately followed suit by increasing their own rates. 

How did bankers react to calls for interest rate caps?

With plenty of anger. Martin Oduor-Otieno, head of Kenya Commercial Bank, the country’s biggest lender by assets, told The Banker that it would be “suicidal” to bring back interest rate controls. “We understand that interest rates are very high at the moment,” he said, “but that is a reflection of the macroeconomic environment. It is not driven by the commercial banks.”

Others added that far from making it easier for small businesses and individuals to borrow, interest rate caps would simply force banks to stop lending to them. They said it was nonsensical that while the government’s two-year bond curve was yielding 23%, some MPs were saying that lenders should be allowed to charge no more than 22% for their loans. There was no way, they insisted, the banks could justify to their shareholders lending to the private sector at lower rates than to the government.

There were also widespread fears that Kenya’s position as east Africa’s financial hub would be badly damaged and that foreign investment – into the financial sector and more broadly – would dry up.

Kenyan banks swerve interest rate cap

What was the outcome?

The proposals were eventually defeated in late April, with MPs voting 58-17 against them. Some analysts said the result testified to the government’s desire to have a mature financial system – the finance ministry and central bank were, after all, always on the banks’ side. Others were more sceptical, with several local news reports suggesting that MPs had come under pressure from Kenyan banks to reject the amendments.

Is that the end of the matter?

For the time being. But Martin Ogindo, the legislator who led the campaign to introduce interest rate caps, says: “We have lost the battle but not the war. The need to have affordable credit in this country is still enormous.”

There is the possibility that similar amendments will be put forward for 2013’s finance bill. With elections increasingly looking likely to be held in March 2013, the timing could be perfect for MPs wanting to drum up as much support as possible on the eve of the polls.

But by then interest rates could well have fallen due to market forces. Kenya’s inflation has fallen in recent months, thanks to the central bank’s moves in late 2011 and a better food harvest earlier this year. The central bank still had its main rate at 18% in mid-May – and thus banks’ own lending rates remained high – but most analysts are confident that it will start to loosen monetary policy in the coming few months. If so, pressure on banks, as long as they bring down their rates in tandem with the central bank, is likely to ease significantly.

Were the proposals a sign of things to come in Africa?

No, particularly among the continent’s larger economies and those with its most developed financial sectors. The amendments, had they passed, would have made Kenya an outlier and signified that it was moving in the opposite direction to Africa’s other big markets, most of which are being liberalised by governments keen to see them developed and attract investment, both from locals and foreigners. 

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Read more about:  Africa , Kenya , Reg rage , Regulations