Kenya’s interest rate cap law has had “unintended negative consequences” on credit availability for small and medium-sized firms, and is also undermining the effectiveness of monetary policy, according to a visiting review team from the International Monetary Fund.
Last year, Kenya’s president signed a law capping interest rates for bank loans at four percentage points above the Central Bank base rate. It also stipulates that fixed deposit interest rates should be at least 70% of the main policy rate.
“Preliminary information suggests that these controls have had unintended negative consequences on the availability of financing for small and medium-sized enterprises, with the risk of reversing the remarkable increase in financial inclusion observed in recent years,” the IMF statement said.
It added: “In addition, interest rate controls are undermining the effectiveness of monetary policy aimed at ensuring price stability and supporting sustainable economic growth.”
Indeed, credit to the private sector in Kenya has slowed since the law came into effect – although it had been slowing even before the law was signed. In December, year-on-year growth of credit to the private sector was 4.9%, the slowest pace since 2003, according to Bloomberg.
However, private sector credit growth expanded slightly in the fourth quarter of 2016 – the first full quarter after the law went into effect – compared to the third quarter, according to Kenya’s central bank. Bank credit to the private sector was 1.4% in the fourth quarter, compared to 1.2% in the previous quarter.
On the other hand, lending rates declined in the quarter compared to the previous period. The average lending interest rate fell to 13.88% from 16.55% in the third quarter, according to Kenya’s central bank; it credits the fall to the implementation of the rate capping law. The average deposit rate rose to 7.60% in Q4 from 6.67% in Q3.
The IMF’s call reflects an assessment by the central bank of Kenya in its Monetary Policy statement for March. A review of analyses on the impact of the law by the bank found that private sector growth had stabilised at 4.0%, and the share of loans to corporates had risen compared to business and personal loans.
The review found that lending to micro, small, and medium enterprises had declined in value terms, with medium and large banks leading the reduction in lending. This was mainly because of tighter credit standards applied by banks.
Banks are also approving more short term loans, even as loan applications in the quarter to 31 December 2016 rose. Loan approvals in the quarter, however, declined by 6%.
“The Committee remains concerned about the prevailing uncertainties, including the impact of the interest rate caps on the effectiveness of monetary policy,” the policy statement said.
The concern seems to be the effect of the caps on private sector creditor growth, as the preliminary analyses show credit to some sectors has been moderated rather than stimulated by the law. That informed the monetary policy committee’s decision to keep the policy rate unchanged, even with rising inflation.
Still, the bank – which strongly opposed the interest capping law – suggests it is still waiting for more data, and time, before it can give a firm assessment of the law’s impact on lending. It notes that “banks are still adjusting their business models to ensure they remain competitive in the new environment.”
Kenya’s government also says more time is needed before the law’s full impact is understood. In March, the secretary to the treasury said it is inaccurate to blame the slowdown in private sector credit growth on the law as it had been decelerating for a while – before the law was signed.
The central bank’s monetary policy statement released that month said the slowdown in private sector credit had more to do with sectoral development and other economic factors. These include a slowdown in exports by the manufacturing sector, delays in registration of land titles and building approvals, and availability of alternative external financing for key private sector projects.
Kamau Thugge, the treasury secretary, also pointed to sustained economic growth – 5.9% in Q1, 6.2% in Q2, and 5.7% in Q3 – as proof that the law’s negative effects could be amplified yet not fully known.
The Kenya Bankers Association, basing on a survey it commissioned, says most bank customers are “not necessarily borrowing or saving more because of the Act.” This contradicts its goal of making credit more available and affordable. The association says banks have tightened credit standards and moved away from risky sectors since the law came into force.
“Slowdown in credit to the private sector has been worsened by the legislation, with disbursement of credit concentrated in four sectors, namely: Household; Trade; Manufacturing; and Building and Construction,” KBA said in a statement.
“This move away from micro-borrowers and SMEs is a concern for us as this segment is where we see most impact in terms of employment creation and sustainable economic growth,” the association’s chief executive said last month.
But, as the central bank points out, the banks are still adjusting to the law – and they seem to have adopted a cautious stand. Whether this becomes entrenched – suppressing the growth of SMEs that have taken the biggest hit – or the banks come round remains to be seen.