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February 23, 2019

Is the law needed to lower interest rates?

Parliament Proceedings
Parliament Proceedings

Opinion is dividend as to whether the President should accent to the Banking (Amendment) Bill2015 that was passed by Parliament last week. The bill proposes a maximum on the interest rates charged on loans and a minimum rate of interest on savings. However, the proposed rates are not absolute, but are instead referenced to the Central Bank Rate at a margin/discount of four per cent. For instance at the current CBR of 10.5 per cent, the maximum lending rate would be 14.5 per cent, and the minimum savings rate 6.5 per cent per year. This gives the industry a spread of eight per cent, which is above the average 6.8 per cent quoted by the World Bank for low and middle income countries.

 Admittedly, the general consensus is that lending interest rates are too high for capital investment that is necessary for economic development. At the same time, deposit rates are too low to incentivise mobilisation of savings. Often times, the resulting interest rate spread, which is the difference between the rate charged on loans and the rate paid on savings, exceeds 15 per cent for the SME business segment. Research has shown there is a negative co-movement between the country borrowing spread and its real economic activity or output. This means low interest spreads are associated with economic expansion. Conversely, high interest spreads are characterised by low economic activity.

 The point of departure is on how to achieve lower rates, and more specifically whether legislation is required, or market forces are better suited to achieve the desired level of interest rates.

 The concern on the high interest rates was raised in the National budget of 2015-16, which adopted four proposals by the high-level committee on the Cost of Credit and Constraints in Mortgage Finance. One, the Kenya Bankers Reference Rate was introduced as a basis for pricing credit. Two, the Treasury Mobile Direct Programme, an M-Akiba bond to allow retail investors to purchase government securities that would offer a better rate on savings, was proposed. Three, it was proposed to modernise lands and companies registries in order to facilitate quicker collateral process and the development of an electronic registry for moveable assets. Fourth and finally, government committed to ensure its borrowing does not crowd-out the private sector by containing the fiscal deficit and adopting alternative sources of funding.

The proposal on KBRR has since been implemented, while the proposal on M-Akiba is pending. The proposal on the registries is in progress, and positive steps have been taken to ensure government borrowing does not crowd-out the private sector. However, the effectiveness of the initiatives in reducing interest rates, admittedly in different stages of implementation, is yet to materialise.

 Perhaps it is not yet time to cast the dice for legislation. On the other hand, perhaps we have run out of options, and the law is a necessary evil under the circumstances.

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