The Accountant Nov-Dec 2016

Finance and Investment
INTEREST RATE
CEILING
By Musyoki Muindi, muindimusyoki@gmail.com
Rate of interest is the amount
of interest due per period, as
a percentage of the amount
lent, deposited or borrowed.
Interest rates are influenced
by the currency of the principal sum
lent or borrowed, the term to maturity
of the investment, the perceived default
probability of the borrower, and the supply
and demand of finance in the market.
It’s good to appreciate the fact that
between 1906 and1992 (86 years) interest
rates in Kenya were capped, profits were
reasonable and banks prospered. After
market liberalisation in 1993, however,
banks started making abnormal profits.
Attempts to redress the situation through
The Dondebill (2000) and The banking
(amendment) Act 2015 received very
hostile response from the banks. Kenyan
scholars and citizens argue that banks
have been practicing oligopolistic interest
rate pricing where loan pricing does not
reflect market fundamentals, the banks
cannot self-regulate themselves, and thus
the proposal to cushion loan consumers
against predatory bank loan interest
through interest ceiling is plausible.
The debate on interest rate ceiling
in Kenya is somewhat polarised, with
consumer protection establishment
groups and poverty campaigners opposing
the government technocrats and the kinda
bankers association. Key concern is on
consumer protection against the activities
of lenders, who are seen as exploitative in
extending high cost credit to vulnerable
low income borrowers resulting in “debt
spiral” which is associated with the risk of
financial breakdown.
In countries where the debate is
structured like the USA,UK and Japan, a
lot of constructive discussions have taken
place. Japan has progressively reduced
interest rates over the decades and has
the strictest interest rates ceilings. The
Citizens Advice Bureau of the UK,
The world Bank and the CGAP (The
consultative group to assist the poor) have
all rejected introduction of interest rate
ceilings. They argue that ceilings:
(a) Open doors to illegal lending;
(b) exclude from the credit market those
who already have little choice and generally
hurt the poor; (c) reduce the diversity
of credit products offered in the market
and adversely affect the extend of credit
rationing; (d) make the lenders narrow
their risk pool, so that high risk borrowers
find it increasingly difficult to obtain
credit; (e) pushes lenders to withdraw
from the markets where they do not make
enough profits; (f )leads to a significant
fall in use of credit, as evidenced in Japan;
and (g)makes lenders also set minimum
lending levels higher than is appropriate
to the needs of low income and high risk
borrowers.
Extensive consumer research in
countries with and without rate ceilings
undertaken by the department of Trade
and industry to inform the UK 2006
consumer credit Act was part of the
evidence base that informed the UK
government’s conclusion that a rate ceiling
would create credit exclusion among the
poor and that it would also open doors
to illegal lenders. In Japan illegal lending
arising from credit exclusion saw one
million arrests in the five years leading
up to passing of the latest credit market
legislation-2006. The Japan federation
of bar association, a highly influential
association of attorneys, asked for a review
and abolishment of rate ceilings.
In order to ameliorate and prevent
continued increase in interest rates, and
force down cost of credit to levels seen as
more socially acceptable, five options are
recommended as stated herein after. These
include:
(i) the most powerful mechanism for
lowering interest rates is competition.
The government should create an
environment that fosters competition.
(ii) Improve efficiency. Greater efficiency
and scale will lead to lower rates.
(iii) Introduce measures to stimulate price
sensitivity among consumers through
provision of facilities for price comparison.
(iv) Strengthen good business ethics
besides compulsory data sharing between
lenders (v) Establish alternatives like
consumer protection laws and a mandatory
transparent disclosure of loan costs.
In conclusion, the mushrooming
financial innovations in Kenya in form
of SACCOs and mobile money will in
the long run cause the cost of credit to
readjust itself to acceptable levels. As
market stability deepens and foreign
exchange markets become buoyant,
whether President Kenyatta signed the
Banking (amendment) Act 2015 into law
or not, interest rates would naturally come
down. Banks will not make supernormal
profits for long.
NOVEMBER - DECEMBER 2016 37