Kenya’s parliament is proposing that the country pegs interest paid on deposits as a fraction of the rate that banks charge customers for loans, reigniting the debate on introducing interest caps.

In its August report on the state of the economy, the Parliamentary Budget Office (PBO) — the agency that advises the country’s lawmakers on how the economy is performing — said banks have been reluctant to raise rates on deposits while they continued charging high interest rates on loans.

“The high interest rate spread in commercial banks remains a source of concern, with banks making supernormal profits at the expense of depositors. In order to narrow the spread and protect the welfare of depositors, deposit rates could be set as a specified proportion of a bank’s base lending rate,” said the office in the report released last week.

Rising inflation

Whereas the country’s banks charge an average interest rate of 16.97 per cent, they only offer an average of 1.73 per cent on customer deposits, meaning that the interest rate spread — the difference between what banks pay depositors and the rate banks charge on loans — is 15 per cent.

The PBO said such a policy on deposit rates, coupled with cheaper banks loans, should give the economy a much-needed boost. Lending rates have been on a consistently downward trend, albeit slight in recent months following the reduction in the Central Bank Rate, which currently stands at 8.5 per cent.

Ideally, this should signal commercial banks to lower their lending rates, thereby boosting private sector credit. The CBK’s Monetary Policy Committee (MPC) meets on Tuesday this week to assess the state of the economy and discuss the CBR.

Inflation has been rising over the past three months from 4.05 per cent in May to 4.91 per cent in June and a 12-month high of 6.02 per cent in July. The surge in inflation is likely to inform the direction the CBK will take on the CBR.

Since the beginning of the year, Kenya has enjoyed a fairly stable inflation rate that was well within the government target of 5 per cent.
In a report released on Friday, the National Treasury says Kenya’s economy is expected to grow by 5.6 per cent this year, up from the 4.7 per cent of last year, aided by a buoyant agriculture sector and expanded infrastructure.

The country is hoping to attract more foreign direct investment in the wake of a smooth political transition that has raised business leaders’ confidence in the economy to new highs.

“Stabilising prices will be crucial to achieving this growth. A stable macroeconomic environment is a critical prerequisite for financial services development,” said Treasury Secretary Henry Rotich.

Kenya’s listed firms are banking on the renewed confidence in the economy to grow their profitability further, with most posting impressive results in the current reporting period. On Thursday, KCB Group reported an 18 per cent increase in net profit to Ksh7.1 billion ($83.5 million), making it the most profitable of the five biggest banks.

Equity Bank reported a 16.75 per cent growth in profit after tax to Ksh6.3 billion ($73.3 million), Standard Chartered Bank’s profits remained flat at Ksh4.52 ($53.1 million), while Co-operative Bank posted a 17 per cent rise to Ksh4.7 billion ($55.2 million). Barclays Bank earnings dropped from $48.5 million to $42.5 million.

Over the past two years, a section of Kenyan legislators have attempted to put in laws defining the level of interest spreads that Kenyan banks should charge, but the efforts have flopped.

In February last year, a parliamentary committee set up to investigate the reasons for the shilling’s rapid depreciation — it had lost about 30 per cent of its value in a space of less than three months — had termed the prevailing interest rates as “unrealistic, harmful and untenable,” recommending that parliament and stakeholders should find a way of lowering the rate.

However, parliament did not adopt the report. Customer deposits are the source of 80 per cent of banks funds and interest rates paid on these deposits average 30.6 per cent of the bank’s operating expenses. Thus an increase in these rates could potentially lower the earnings of banks.
Banks are opposed to such proposals, which could eat into their profit.

“Limiting lending rates statutorily is likely to lead to credit rationing, and 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,” the Kenya Bankers Association said in an earlier statement.

In an interview with The EastAfrican last week, CBK Governor Njuguna Ndungu termed interest rates capping “one of the biggest misconceptions in Africa,” arguing that banks record the earnings that they do largely because they lend to the government, so interest rate spread concerns need a more comprehensive approach rather than just capping them.

“What is needed are market solutions to address the structural constraints leading to the high spreads. As an example, the CBK participated in a study on the collateral process in Kenya that is one of the main handicaps to securitisation of loans and adds massive costs to loan applicants, and sometimes drives them away,” said Prof Ndungu.

The governor further said that deepening credit information-sharing mechanisms would also help deal with the information asymmetry that leads to high interest spreads.