An increasing interest rate can have both good and bad effects on an economy. Our government’s decision to introduce an interest rate ceiling cap has various effects on our accessibility to loans, especially when you are running a business venture.
What does the Banking Amendment Bill 2015 entail?
On 24th September 2016, President Uhuru Kenyatta assented to amendments on the Banking Act of Kenya. The Bill created in 2015 requires banks to limit interest rates to a maximum of 4 percentage points above Central Bank of Kenya Rate. The Law also compels the financial institutions to disclose all term and fees relating to a loan. To understand what the bill means for customers we must examine how interest rates affect loans.
What Is an Interest Rate?
This is a rate charged by a lender for the use of money borrowed from them. It is usually expressed as a percentage of the principal (original amount borrowed) on a yearly basis. The rates fluctuate as a result of inflation and other economic policies.
How Do Interest Rates Function?
Lenders are aware that not all customers who access loans will be able to repay them. Therefore, they charge interest as a way of recovering their initial investment. The setting of interest rates begins with the Central Bank of Kenya. The Central Bank sets the base rate (rate at which one lender pays another to borrow money). This in turn impacts the rate charged to private borrowers.
Apart from the Central Bank Rate, personal factors can also affect interest rates. These factors are:
- Banks and private lenders usually assess the borrowing history of a customer to determine his credit worthiness. A borrower with a history of defaulting of loans will be subject to higher interest rates than one with a consistent repayment history.
- Long-term loans attract higher interest rates compared to short-term loans. For long-term loans the lender runs the risk of borrowers defaulting when financial difficulties arise.
How Can The Changes In Interest Rates Affect Your Business?
For small and medium enterprises (SMEs) the financial well-being of their businesses depend on stable favorable interest rates. Here are some ways interest rates affect businesses:
- Enterprise planning: High interest rates may erode a company’s earnings and slow down its ability to grow. Low interest rates on the other hand make credit affordable. As a result many companies are able to expand during low interest rates period.
- Managing Debt: SMEs with variable rate loans may suffer when interest rates rise as the amounts of payments increase. The uncertainty makes it hard to plan and forecast for loan repayments. Businesses with fixed rate loans are however not affected by fluctuating interest rates.
- Cash Flow: Small businesses are affected by high interest rates. More money is spent on settling debts and making loan payments than meeting other business obligations.
- Company Sales: High interest rates limit the amounts consumers can spend on a company’s products. Majority of the consumers will be more concerned about meeting their debt payments. On the other hand lower interest rates free up customer incomes and they are willing to spend money on various commodities.
Availability of credit is important for business growth and expansion. The new lending rates in the country are aimed at giving people and businesses access to cheap loans and safeguarding consumer interests. Provided you have a good credit score with your bank, the implementation of the law should lead to more favorable interest rates for business loans.