Why cost of loans will remain high for Kenyan borrowers

Opinion and Analysis

Treasury Secretary Henry Rotich plans to float a diaspora bond and an Islamic bond (sukuk) next year. PHOTO | FILE 

By ANZETSE WERE

It has been argued that reduced domestic borrowing by the government would ease pressure on demand for domestic credit and lead to lower interest rates.

Another argument is that introduction of the Kenya Banks Reference Rate (KBRR) will let consumers know how much credit should cost and thus foster competition in the banking industry, which will lead to lower rates.

Yet since the introduction of the KBRR only one bank has lowered its interest rates. Further, even after announcements by the government signalling that it would borrow from outside Kenya, interest rates have not dipped in any significant way. Why aren’t banks lowering interest rates in any noticeable manner?

There are several factors at play which will not only ensure that interest rates do not go down but may push them up. The focus here is on external factors that inform rate setting rather than internal dynamics of banks — such as riskiness of client, required rate of return on capital — as these are harder to influence and ascertain.

The first factor is the cost of borrowing. According to the Central Bank of Kenya (CBK), in November the average interbank lending rate see-sawed between 6.39 and 7.6 per cent.

The lenders, however, look at long-term trends of the inter-bank rates when setting the cost of lending to each other. Industry insiders say the real rate can be double the November figure.

Banks ordinarily on-lend at a rate higher than that at which they borrow cash, so the inter-bank rate is the first real cost that hits consumers.

Inflation is another factor that informs rate setting. High inflation devalues the shilling and pushes rates up in order for banks to recover the equivalent value of capital.

The inflation rate in Kenya averaged 11.13 per cent from 2005 until November 2014, well above CBK’s target rate of 2.5 to 7.5 per cent.

Given how unstable Kenya’s inflation rate is year-on-year, banks would rather err on the side of caution and keep rates up to ensure they get the value of their money back. Another factor banks have to consider is tax. The corporate tax rate obviously eats into profits.

The tax in Kenya stands at 30 per cent for residents and 37.5 per cent for non-residents. However, a 2013 report by PricewaterhouseCoopers found that a company in Kenya on average pays a total tax rate of 44.2 per cent, higher than the global average of 43.1 per cent.

Further, it takes a firm operating locally 308 hours to comply with taxes; while the global average is 268 hours. These factors lead to a high cost of doing business in Kenya which leads to a higher financial burden in terms of man hours.

So it can be understood why some of this financial burden is passed on to consumers in the form of higher interest rates.

Additionally, for banks listed on the Nairobi Securities Exchange withholding tax on dividends stands at five per cent for residents of the East African Community.

The rate is 10 per cent for non-residents. To top it all, the government recently announced the re-introduction of the capital gains tax at five per cent.