This article first appeared in my weekly column with the Business Daily on December 17, 2017
The interest rate cap and the effects it has had on the financial sector, specifically banks, has been a consistent feature in discussions about business and economics in Kenya this year. The main effects of the cap have been a notable contraction in liquidity particularly to SMEs. Banks are of the view that the cap has limited their ability to build risk into loan pricing and thus prefer to lend to government and larger companies. However, there are ways through which the interest cap, perhaps inadvertently, helped banks given the turmoil it has created in the sector.
Firstly, the cap has forced the sector to become more efficient. In order to cut costs to, partly, manage the effects of the cap, banks have put in several measures such as closing branches, reducing employee numbers and leveraging automation. Technology has been aggressively brought on board via new features, such as PesaLink, that reduce the need for staff to receive and process payments. Low performing branches seem to have been shut down and over 2,000 staff have been laid off. Perhaps the cap fast-tracked these efficiency measures since it was clear that automation, for example, had been part of long term plans for the sector. That said, the cap has forced banks to become leaner and more efficient entities in order to protect profit margins.
Secondly, the cap may well have started a conversation among bank management on their risk assessment tools. It is an open secret that banks in Kenya are risk averse and generally want security in the form of assets or a monthly pay cheque against which they issue credit. Perhaps the cap has forced banks to rethink their risk assessment tools in order to better delineate high versus low risk clients. It is time the banking sector created more sensitive tools that look beyond assets and monthly salaries to determine whether credit will be offered or not. The reality is that there are relatively high income Kenyans who would likely be safe bets but have ‘informal’ sources of income that tend to be immediately classified as high risk by banks. It is time banks sophisticated their risk assessment tools to more clearly determine to whom they should lend. Hopefully the cap catalysed a conversation in this direction.
Finally, the cap has perhaps woken the sector up to the need to be seen as an ally of the Kenyan people. One of the factors that informed the implementation of the cap was the widespread feeling among Kenyans that banks were greedy shylocks that deliberately over-priced loans with little concern over the onerous weight such pricing placed on Kenyans. Indeed disgruntlement with the banking sector is what led to popular support for the cap in the first place. Thus, hopefully the cap has made the sector more fully appreciate the need to be an ally of the Kenyan people by pricing loans more reasonably in the future.
Anzetse Were is a development economist; email@example.com
This article first appeared in my weekly column with the Business Daily on July 9, 2017
The interest rate cap has led to several consequences, some of which have been elucidated in this column. The most concerning are the effects is has had on monetary policy and access to credit for the private sector. However new medium to long-term effects are beginning to emerge.
The first is that, private sector, particularly SMEs are getting used to functioning without the credit lines on which they used to depend. Data from the CBK indicates that credit to the private sector expanded at 3.3 percent in the year to March 2017, the slowest rate in more than a decade. So while some private sector may be turning to the shadow lending system for credit, many more may be growing accustomed to getting by with no credit lines at all. In effect, the cap may be dampening the private sector’s appetite for credit. Thus the concern is not only that the economic engine of the country is being starved of liquidity, the engine may be getting to used to ticking away at sub-optimal levels due to poor access to credit with dire consequences to GDP growth. GDP grew at just 4.7 percent in the first quarter of the year, and although part of this is due to a contraction in agriculture, the cap has also informed the sub-par growth. Will dampened appetite for credit become a long-term trend or will private sector aggressively take up credit lines if the cap is reversed?
Secondly, since the cap has made government the preferred client for many banks, the cap has created the very situation government has been stating it has been trying to avoid and that is crowding out the private sector. Thus the irony is that in government assenting to the cap, it has created the very situation it sought to circumvent. Indeed in the 2017/18 financial year government plans to finance 60.7 percent of the fiscal deficit using domestic sources. In the past government would somewhat limit heavy borrowing from domestic markets but in the age of the interest rate cap, government is well aware of its priority status and thus seems to be leveraging this to finance the budget with domestic sources perhaps more aggressively than had previously been the case. Will this become a long-term habit that proves difficult to break?
Thirdly, however, there is a silver lining in the cloud; banks are going to come out of this period more efficient than ever. The cap has caused banks to ask themselves hard questions such as: how much labour is actually required to effectively meet client needs? How many branches need to remain open to serve clients and hit targets? The cap may be accelerating the automation drive that had already began to occur in the banking sector and banks should embrace this era of capped rates to become more efficient. Banks will likely emerge from the interest rate cap as leaner and more efficient entities than would have been the case if the cap hadn’t been effected. This is a long term effect on the banking sector and may well have lasting benefits on profit margins.
Anzetse Were is a development economist; firstname.lastname@example.org
Kenyan banks present a voluntary plan to gradually reduce lending rates. Johnson Nderi of ABC Capital and I analyse the proposals.
This article first appeared in my weekly column with the Business Daily on October 25, 2015
After the government announced that it had acquired a two-year, Sh77.43 billion ($750 million) syndicated loan, some banks raised their interest rates. This raised questions about what happened to the billions raised via the Eurobond and the implications of rate hikes on the economy. However, the truth of the matter is that there are several compounding variables with which CBK has to contend; variables that put pressure to keep rates high as well as pressure to lower rates.
In terms of the pressure to keep rates high one need only remember that the CBK raised the Central Bank Rate (CBR) to 10.0 percent in June 2015 from 8.50 percent and then raised it again to 11.5 percent in July 2015. These hikes were done in an attempt to stem the depreciation of the shilling and control upward inflationary pressure. This act was arguably warranted given that Kenya is an import economy and has to service foreign denominated debt which currently stands at about 50% of total debt. Therefore, if the KES depreciation is not managed, import bills will become more costly and foreign denominated more expensive to service. These are real short to medium term pressures that the government has to manage.
Of course the problem with raising interest rates is that it often has a dampening effect on economic growth due to reduced investments and consumption. Therefore in keeping rates high further strain will be put on economic production and GDP growth. This will happen in the context of economic performance that has been so anemic that both the World Bank and the government revised GDP growth figures downwards. High interest rates will likely exacerbate the subpar performance of the economy and government will fail to generate the revenue required to pay import bills and service debt. Therefore in this scenario, CBK has to tussle with keeping rates high to stem KES depreciation and control inflation while contending with the negative consequences of doing so.
At the same time, there is pressure to lower rates. As mentioned, high interest rates tend to dampen economic growth and Kenya cannot afford this. So there is good reason for rates to be lowered, clearly the economy needs it. Lower rates will enable economic productivity, support economic growth and allow government to generate much needed revenue. However, if interest rates are lowered it risks prompting the devaluation of the shilling and enabling upward inflationary pressure. A weak shilling will mean import bills are more expensive and may make servicing foreign debt unaffordable. High inflation will raise the cost of living which will mean that basic goods such as food become more expensive for Kenyans. This is when the politics of economics comes in; no government wants to be in power when basic goods become unaffordable as social unrest usually ensues. Therefore, although there is pressure to lower interest rates, the potential negative consequences of doing so are not phenomena with which any government would want to contend.
In short, there are dangers in keeping rates high and dangers in lowering rates; so what should the CBK do? In my view, given the fact that there is extra incentive to raise rates due to heavy domestic borrowing by government, the CBK should lower rates. This is because government borrowing has prompted rate hikes beyond what CBK had orchestrated. Therefore, a lowering of the CBR will buffer the economy and Kenyans from the recent hike in rates.
However, the situation the economy is in right now has made one thing clear; Kenya’s economy cannot continue to be structured as it is. There must be concerted and deliberate action by government to plan a fundamental reorientation of the economy in which more forex is earned. This can be done through increasing exports and diversifying our export profile, as well as supporting forex earners such as tourism.
Anzetse Were is a development economist; email: email@example.com
There are myths told to Kenyan consumers on a regular basis. One myth is that if government does not borrow locally, it should lead to lower interest rates because of the ease of pressure on demand for domestic credit. The second myth is that the Kenya Banks Reference Rate (KBRR) will let consumers know how much credit should cost and thus foster competition in the banking industry which will lead to lower rates. Yet since the introduction of the KBRR only one bank has lowered its interest rates. Further, even after announcements by government clearly signalling that it will borrow from outside Kenya, interest rates have not dipped. Why? Why aren’t banks lowering interest rates in any noticeable manner? There are several factors at play that will not only ensure interest rates do not lower but in fact may push interest rates up. The focus here will be on external factors that inform rate setting rather than internal dynamics of banks (such as riskiness of client, required rate of return on funds/capital etc) as these are harder to influence and ascertain.
The first factor is the cost of borrowing; according to the CBK, during the month of November the interbank lending rate seesawed between 6.39 and 7.6 % but often more long term rates are used and insiders say the real rate can be double this figure. Banks have to on-lend at a rate higher than that at which they borrowed so this borrowing rate is the first rate- hike that hits consumers.
Inflation is another factor that informs rate setting since high inflation devalues the shilling and therefore pushes rates up in order for banks to recover the equivalent value of capital. Calculations on long term inflation demonstrate that the Inflation Rate in Kenya averaged 11.13 % from 2005 until November 2014, well above CBK’s target rate of 2.5-7.5%. Given how unstable Kenya’s inflation rate is year on year, banks would rather err on the side of caution and keep rates up to make sure they get the value of their money back.
Another factor banks have to consider is tax. The Corporate Tax Tate since this obviously eats into profits. Corporate Tax Rates in Kenya currently stand at 30% for residents and 37.5% for non-residents. However, a 2013 report by PriceWaterhouseCoopers found that a company in Kenya on average pays a total tax rate of 44.2%, higher than the global average of 43.1%. Further, it takes a firm operating locally 308 hours to comply with taxes; the global average is 268 hours. These factors lead to a high cost of doing business in Kenya which leads to a higher financial burden in terms of man hours. So it can be understood why some of this financial burden is passed on to consumers in the form of higher interest rates. Additionally, for banks (and any other company) listed on the Nairobi Securities Exchange Withholding Tax on Dividends stands at a rate of 5% for dividends paid to residents of Kenya and on listed shares for citizens of the East African Community; the rate is 10% for other non-residents. To top it all off, the government recently announced the re-introduction of the Capital Gains Tax at 5%. Banks are facing millions of shillings in tax charges on transactions starting January 2015. Such tax burdens increase the cost of funds and puts pressure on banks to find ways to secure profit margins and hiking interest rates is a viable option.
There are also non-financial reasons why banks feel no pressure to reduce interest rates: Kenyans do not necessarily choose banks due to their interest rates and Kenyans do not necessarily leave banks if the interest rate goes up. There are other factors that inform how Kenyans choose banking partners or stay with them. A study by Ernst and Young earlier this year indicated that Kenyans, like millions of others across the world, open and close their accounts due to customer experience and this factor is more important than fees, rates, locations, press coverage or convenience. Add to this the reality that Kenya recorded a higher than average increase in confidence in their banks. In fact, while 44% of customers around the world express complete trust in their banks, this figure is 59% in Kenya; the highest level in Africa.
Given all these factors, why would banks seek to drive down interest rates? It appears as though banks would prefer to reward depositors with higher interest rates and general customers with better services than bring lending rates down. Sadly, no reprieve is in sight for you, Kenyan borrower.
A version of this article was featured in the Business Daily on December 1, 2014. You can read it here.