By Morris Aron
The intense parliamentary debate on theFinance Bill 2011 demonstrated the level of controversy that surrounds interest rates charged by banks on its customers.
Finance experts say that the development stems from the realisation that commercial banks are making extra-ordinary profits at a time when nearly all sectors of the economy are reeling from the effects of the economic slowdown — a pointer that there is a loophole they are maximising on.
Just like the famous Donde Bill, the recent proposal to cap interest rates has re-kindled a can of worms that border on ethics, profitability, risks and business practice.
In addition, the country is currently operating in breach of the Constitution after delaying with the implementation of Finance Bill and three other crucial Bills.
Finance experts say for one to fully grasp which way the argument will go can only be understood by truthfully answering three questions.
One, is the level of interest rates charged by banks compared to the Central Bank Rate — the rate at which Central Bank loans commercial banks as a lender of last resort—representative of market dynamics or bordering on exploitation?
Two, are the country’s interest rate spreads — the difference between what a customer gets when they deposit money at banks and what banks charge when they loan out money — too big or justified?
Three, is the proposed law to cap interest rates levied by banks the best way to address the interest rate problem?
Finance experts say that having a law to cap interest rates would not only help distort market fundamentals, but also herald a non-liberalised market.
According to this school of thought that is hugely popular among bankers, interest rates charged in the market should be left to the famous law of demand and supply.
In the course of December last year, banks warned that attempts to cap lending rates would make it harder for borrowers to obtain loans and increase hidden charges.
"Limiting lending rates statutorily is likely to lead to credit rationing and lead to an increase in hidden charges to compensate for lost interest revenue resulting in less access to credit for small borrowers who constitute the highest number of the bankable Kenyan population," said Kenya Bankers Association (KBA) chairman Richard Etemesi recently.
Risk factor
A similar position has been taken by a number of chief executives of several commercial banks and even tax and auditing experts.
"The banks will avoid persons whose risk factor may exceed the set limit," said Greg Brackenridge, Managing Director at CFC Stanbic Bank.
"I have always advised against any attempts to fix interest rates in the Constitution. Because when the market fortunes change what do you do then,’’ asked Sammy Onyango, the Managing Partner of Deloitte East Africa.
The amendments which were to be introduced to Financial Bill 2011 mid December and which now have to wait until the sitting resumes this year seeks to cap banks’ lending rates to four percentage points above the central bank rate (CBR), while setting the minimum interest rate on deposits at 70 per cent of the CBR.
The debate came alive after the reality of the recent hikes in the CBR rates to tame inflation and foreign exchange volatility began to hit home. In the last three months, the Central Bank has raised the CBR by 11 per cent to the current 18 per cent — a move that has seen interest rates rise to as high as 27 per cent in some banks.
According to the legislators behind the proposed law, banks’ lending rate should be capped at 22 per cent, while the minimum return to customers’ deposits should be 12.6 per cent.
Proponents of the Bill say that commercial banks have been enjoying wide interest spreads, hence pocketing huge profits.
The wide interest rate spreads has been a subject of debate among experts with bankers saying that it is justified due to what they term as ‘structural rigidities.’
Those opposed to the development say that banks use the spread to rake in profits at the expense of their customers who are faithful enough to deposit money with them.
In a recent statement that could have hinted to the banks how the huge interest rate spreads are not favoured in the eye of the public, President Kibaki last June urged banks to review their credit policies and noted with concern the high interest rate spreads.
Kibaki said that banks should not hide behind high credit risk as a reason for the high spread.
Banks on their side have always maintained that risk structures were to blame for the high interest rate spreads, as they seek to cushion themselves from any cases of loan default.
However, recent realisations that banks actually set their profit margins at the beginning of the year pegged mostly on the interest rate spreads has seen public opinion turn against them.
Banks have also been accused of not passing benefits of reforms initiated by the regulator to lower the cost of doing business to their customers.
Currently banks’ minimum lending rates are about 24 per cent. While banks are not mandated to inform the savings rate they offer to retail depositors, some experts say that it amounts to discrimination that commercial banks are willing to negotiate with large depositors for a higher rate.
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