The full impact of the recent capping of interest rates will take time to unravel. With loan interest capped at four per cent of the base rate, and deposits at 70 per cent of the same rate, the interest rate spread or margin is about 7.22 per cent. Data from the World Bank shows the average interest rate spread in lower middle-income countries is 6.8 per cent, decreasing to 6.6 per cent for middle income and 6.3 per cent for the upper middle-income countries. With Kenya regarded as a lower middle-income economy, the maximum spread set by the capping of interest rates could therefore be regarded as reasonable in comparison.
A look at the Central Bank data shows an increasing trend in interest spreads in the recent past. The spread had increased to 11.4 per cent between the lending and deposit rates, and 16.58 per cent between the lending and the savings rates, with the former affecting mainly the SME and individual consumers.
The possibility that reactions to the Act may do more harm than good to the market has been discussed. One, banks are likely to increase other loan processing fees such as appraisal, and set up fees to get back the lost interest income. Two, credit access to the low-income earners and SMEs is likely to reduce, negating the gains made in financial inclusion. Third, we may go back to the old practices of prohibitive minimum balances and account charges that characterised the sector before the financial liberalisation of the early 1990s. It is, however, unlikely that such reactions will be sufficient to cover the lost income without drawing negative reactions from the public.
Granted, while these are possible strategies and reactions to the law, they are by no means a consequence of the law – neither are they the only options available to the market. More responsive strategies will not only address the “customer insensitivity” raised during the signing of the bill, but will ensure banks earn a reasonable return on their investment. Furthermore, with the law already in place, responsive strategies may be the difference between success and failure in the sector. Going forward, the industry and regulator may need to rethink the banking business model with the aim of increasing efficiency, and to ensure the sector remains stable. One of the issues raised this far is the cost of compliance to the ever increasing regulatory requirements, including the minimum core capital. This presents a trade-off between stability and profitability. Another issue is development of credit information that can be used as a credible measure of risk and for pricing purposes.
Karen Kandie is a financial and risk consultant with First Trident