NAIROBI (HAN) August 27.2016. Public Diplomacy & Regional Security News. By Allan Olingo and Bernard Busuulwa. A law capping interest rates in Kenya has stoked fears of copycat legislation in East Africa and a reversal of common integration policies ahead of the launch of a regional monetary union.
By virtue of Kenya being the most developed economy in the East Africa Community, its apparent abandonment of the free market ideals at the heart of the monetary union convergence criteria has left regulators and investors uncertain of the direction of the protocol.
National Bank of Rwanda Governor John Rwangombwa said money managers across the region were waiting to see the impact the caps would have on access to credit but maintained that controls were not always good in managing financial issues.
“National laws are supposed to address national issues. Kenya’s financial sector is the most developed in the region and second to South Africa on the continent. It is a good testing field,” said Mr Rwangombwa.
Under the East African Community Monetary Union Protocol, the member states committed themselves to pursue a free market economy with a floating exchange rate.
“The policy decision could create some disharmony or friction within the region’s banking sector and eventually affect the monetary union integration process,” said Charles Katongole, senior executive at Standard Chartered Bank Uganda.
Joram Ongura, an equities trader at SBG Securities Uganda, said monetary union policy targets could now come under review because they were originally anchored in market determined fundamentals.
The immediate impact in Kenya of President Uhuru Kenyatta signing the Central Bank (Amendment) Bill 2015 into law on Wednesday was a rout on banking stocks listed on the Nairobi Securities Exchange, which shed $840 million in market value by Thursday.
Banking stocks at the Dar es Salaam Stock Exchange, Uganda Securities Exchange and Rwanda Stock Exchange were stable. Even Kenyan bank counters cross-listed in the three bourses were unmoved because they rarely trade.
In Kenya, some banks halted the issuance of new personal unsecured loans, motor loans and emergency cash loans, citing the uncertainty around the implementation of the new law. Co-op Bank bucked the trend, saying it would be lending at the new rates immediately.
“We advise that pending receipt of full guidelines from the Central Bank of Kenya, particularly on the applicable base rate, all new credit facilities shall be at a rate not exceeding 14.5 per cent. Do refresh the relevant facility offer letters in liaison with our credit management division,” Co-op Bank chief executive officer Gideon Muriuki instructed branch managers in a circular Friday.
The law pegs interest rate margins to a base rate commonly understood to be the Central Bank Rate, which is currently at 10.5 per cent (there are contentions it could be the KBRR, which is reviewed every six months) but is revised bimonthly.
It requires lending rates not to exceed four percentage points above the base rate, meaning the maximum interest rate a borrower should pay for a loan is 14.5 per cent.
It also requires deposit rates not to be less than 70 per cent of the base rate, meaning money in interest bearing accounts should now accrue an interest of 7.35 per cent, a far cry from the current less than four per cent. This gives an interest margin of seven percentage points compared with the 14 percentage points obtaining, now with average lending rate at 18 per cent.
The law also seeks to restrain banks from resorting to transaction charges to compensate for the low interest margins by requiring that all non-interest fees related to a loan must be disclosed at the point of signing the contract. Savings and credit societies have also not been left out of the provisions because the law talks of financial institutions, not commercial banks, a broad definition that saw Saccos start paying a 10 per cent excise tax on transactions two years ago.
It is feared the law could distort the flow of capital flight within the region as investors look for good returns on savings and borrowers look for the most affordable credit prompting responses from neighbouring markets.
“This development could stir similar agitation among Ugandan parliamentarians over the issue of high interest rates. Uganda already caps the interest rate that microfinance institutions may charge, at or below inflation,” said Sam Ntulume, managing director of NIC Bank Uganda, a subsidiary of NIC Bank of Kenya.
Experts believe the law will block credit from reaching higher risk borrowers and could force banks into mergers, replacement of staff with technology and to establish subsidiaries in regional markets where interest rates are not capped.
Armando Morales, the International Monetary Fund’s representative in Kenya, said banks may exclude small borrowers from accessing loans and further curb already sluggish private sector credit growth.
“Small firms and individuals could be deemed too risky by banks. By narrowing the spread, it will make it less attractive for banks to continue lending to them at the same pace,” said Mr Morales.
Banks mergers or closures likely
Economist Robert Shaw said banks are now going to carefully categories their clients, with the small time borrowers feeling the pinch as the access to credit is going to be tightened.
“We are going to see banks likely avoid high-risk borrowers such as the small and medium businesses. It does not mean because the rates are lower more people would access credit. Loans will be accessible for some, people with salaries, with consistent incomes where rates will be lower but some out there will find it very difficult to access loans,” said Mr Shaw, adding that this will beat the logic of why it was assented to in the first place.
Analysts from Standard Investment Bank say that over the medium term, there should be bank mergers, acquisitions and at worst, closures.
“Tier three banks and much smaller Tier two banks, which are already struggling to cope with liquidity skewed towards Tier one banks, will be forced to consider mergers or acquisitions on the face of the new bank capitalisation requirements, which will be in place in the next three years,” SIB analysts said in a market note.
CfC Stanbic Bank regional economist Jibran Qureishi said banks are now at a crossroad, especially with the current volumes of non-performing loans.
“It is a given that banks will avoid large volumes of risky credit because that would lead to an increase in non-performing loans and force them to provision, cutting deeper into their already thin margins,” said Mr Qureishi, adding that they will wait for the law to be gazetted, then see how well to fit in within the new legislation before clearing any ambiguities.
President Kenyatta’s statement that he will accelerate other reform measures necessary to reduce the cost of credit is seen as targeting the high domestic borrowing by the government, which has whet the appetite of the banks.For instance, a day after the Bill was signed, Kenya’s weighted average yield of accepted bids for its 10-year $180 million Treasury bond rose to 15 per cent at its mid-week auction.