Banks in Kenya have been smug and lazy, since demand outstrips supply
they have chosen to treat all borrowers the same. PHOTO | FILE
By ZAWADI LEMAYIAN
In Summary
President Uhuru Kenyatta’s decision to assent to the
Banking (Amendment) Act 2015 has no doubt thrown Kenya’s financial
services sector into a tailspin and sparked a vicious public debate that
is likely to persist in the coming weeks.
The law, which many bankers expected the President to
reject, introduces interest caps on loans and minimum rates that banks
must pay depositors.
Besides, it also requires financial institutions to
disclose all loan terms and charges to a borrower prior to granting a
loan, and outlines sanctions for financial institutions that contravene
the provisions.
By the close of last week, public discourse on the
new law was still centered on its possible impact on ordinary consumers
and the Kenyan economy at large.
The reality, however, is that the Bill has been
signed into law and a fruitful conversation around it could only be one
that is centered around how best to implement it to ensure both
consumers and financial institutions are aligned with its intention.
A number of issues stand out with regard to its
enforcement. First, it would be useful to clearly outline whether the
interest rate caps only apply to the loan principal, or the total loan
amount (loan principal, fees and charges).
This is because vagueness in this area is likely to
create loopholes that allow financial institutions to partially comply
with the law even as they come up with new charges, whose ultimate
impact will be to make the total cost of credit to the borrower greater
than the 4.5 per cent cap allowed above the base rate.
Second, financial institutions should be encouraged
to provide better disclosures that allow regulators and other users of
financial information to understand the fees they are charging.
A more transparent information environment will
also help financial institutions to identify areas where operations can
be streamlined to make them more profitable.
Finally, financial institutions can also try to do a
better job at calibrating the cost of providing capital with the
riskiness of the borrower. Much of the frustration among consumers prior
to the enactment of the law was on account of the high cost of
borrowing for both risky and less risky parties.
Consequences of the regulation
While the law’s passage has garnered widespread
praise from consumers, banks and Treasury officials have criticised it.
The biggest benefit will be a short-term decrease in the cost of
borrowing to qualified borrowers.
It is, however, important to acknowledge that the
expected benefits will not accrue to risky borrowers. This is because a
reduction in interest income will make banks to increasingly shy away
from lending to consumers who are likely to default in order to maintain
their profit margins.
Another positive outcome from encouraging banks to
be more cautionary in their lending activities is that it will promote
efficiency and reduce the portfolio of poorly performing loans. The
lower rates will also minimise predatory lending and protect consumers
from onerous terms in debt contracts.
But we should also expect unintended consequences.
Globally, research has found evidence that negative consequences
outweigh the benefits when interest rate caps are introduced on loans.
Opponents of this law have cited possible drying up of credit,
as banks reduce lending, especially to riskier borrowers, who plausibly
benefit greatly from access to capital.
Without access to previously accessible credit, borrowers
are more likely to make poor decisions such as defaulting on current
loans. It also creates incentives for loan sharks to operate illegally
in the knowledge that there is a scarcity of accessible sources of funds
for risky borrowers.
That reality may also lead them into charging even
more exorbitant interest rates than the banks have been charging in the
current regime. Further, the new minimum rates that banks must pay on
deposits may have the effect of reducing banks’ appetite for deposits,
further shrinking access to credit for borrowers who need it.
Finally, there is the possibility of a reduction in
the types of innovative financial products that banks have over the
years produced. Overall, a careful evaluation of these consequences in
the near future and the long term will be necessary to minimise bad
outcomes.
Credit bureaus, consumer literacy
Commercial banks in Kenya argue that default risk
is the leading cause of high interest rates they have been charging
borrowers. However there are bigger issues that need to be tackled with
regard to what measures can be put in place to reduce default risk.
This is because history has shown government
intervention in free markets is never optimal, and introduction of
interest caps does not address the core issue.
Free markets encourage competition, allowing
financial institutions and other firms to create products that best meet
the needs of their consumers.
One of the sustainable ways to reduce default risk
is to improve the current state of credit bureaus. When a lender cannot
ascertain a borrower’s creditworthiness, one way to reduce the risk of
default on a loan is to make borrowing more costly.
Providing readily available and verifiable
information about a borrower’s risk might make it easier for lenders to
screen borrowers. Credit bureaus collect and provide credit information
on consumers. Currently, there are only three credit bureaus licensed by
the Central Bank of Kenya, all of which are all located in Nairobi.
The recent foray by telecoms, utility companies,
the Higher Education Loans Board (Helb) and other institutions into use
of mobile platforms means information about consumers can be obtained in
real time and passed on to the bureaus.
There is, however, still room to grow. At present,
there is no standardised framework for the provision of information and
dispute resolution.
The summary reports on consumers’ creditworthiness
are only as good as the sources of information they are based on. It
might be worth thinking of ways to regulate the provision of information
by these parties to credit bureaus and implement quality control checks
to ensure that the information about consumers is timely and accurate.
This will make it easier for banks to rely on these
reports to screen borrowers and reduce their reliance on informal
sources that are costly and time-consuming. And with fewer
non-performing loans, banks will be able to bring down the cost of
borrowing.
One last critical ingredient of running a
well-functioning, efficient and cost-effective banking system is to
promote consumer financial literacy.
The new law requires banks to disclose all fees to
their customers, but it is more useful to think of ways to educate
borrowers on how to make savvy credit decisions and manage debt.
Such knowledge will help borrowers be better consumers of
credit and make them aware of how much debt is optimal for their needs.
In the long run it will be more effective to
implement strategies that reduce the need to make borrowing costly for
consumers in the first place.
Lemayian is a professor at Washington
University’s Olin Business School with research interests in capital
markets, banking and taxes. zawadi.lemayian@gmail.com
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