In Kenya, there has been a lot of buzz about the bill our Members of Parliament passed on interest rates. The bill sought to amend the Banking Act by placing restrictions on the rate at which banks offer on loans and deposits.
The particular features state that this amendment will put:
- A cap on lending rates at 4.0% above the Central Bank Rate (CBR) which is at 10.5 %
- A floor on the deposit rates at 70% of the CBR
This is not the first time such an Act has been proposed. In 2001, there was an attempt to amend the Central Bank Act and cap the base lending rates at 4.0% above the 91-day T-bill and the deposit rates at 4.0% below the 91-day T-bill, bringing the spread to 8.0%.
In 2013, the Kenyan Parliamentary Budget office proposed the pegging of the deposit rates to the lending rates. In both of this attempts the restrictions to the bill were not successful.
Previously, the interest rates were between 18% to 22 % for unsecured loans. These rates are relatively high as compared to South Africa which stands at 12% while in Japan and in Europe the rates are as low as 5%.
Why does Kenya have such high interest rates:
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Inflation
This is the sustained increase in the general level of prices for goods and services over a period of time. It affects interest rates because the rates that are paid on most loans are fixed in the loan contract. It affects the interest rate because, a lender may be reluctant to lend money for any period of time if the purchasing power of that money will be less when it is borrowed than when it is repaid. The lender will, therefore, demand a higher interest rate on what is borrowed, so as to make up for the lost value. Thus, inflation pushes interest rates higher.
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Competition
The size of the difference between lending rates and deposit rates (the interest rate spread) has been publicly called into question. A recent research paper by Kenya Bankers Association (KBA) has found that the spreads between the deposit and lending rates tend to be larger for larger banks. The same study suggested that this could be a manifestation of market power, which would imply a lack of competition in the market.
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Credit Risk
Credit risk refers to the risk that a borrower may not repay a loan. Most banks classify borrowers as risky and most likely to default their payments. Many banks have therefore increased their interest rate so that they can insure themselves from the effects of unpaid loans.
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Operational costs
The operating costs of banks in Kenya are generally high. Some of these costs include employee remuneration:, security costs and legal costs. The banks therefore pass on this operational expense to the customer and hence the higher rates.
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Customer Awareness
Mr Sam Omukoko, of the Credit Reference Bureau Metropol Corporation was quoted saying, “As long as the customer has no question and knowledge on pricing, they simply bear with the rates”. Many banks do not put out their interest rates in public for the borrowers to view and be able to compare. Customers do not realise that they have the power to negotiate better and more flexible terms of payment with their banks, or alternatively, seek another financial institution.
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