Lower interest rates boon for both banks and their clients

Banks will experience difficulties associated with lower interest rates in the short-term, but they will ultimately prosper as the volume of business grows. PHOTO | FILE 

By JOHN KABIRU

In Summary

• The banking sector plays a pivotal role in determining interest rates under the supervision or regulation of the CBK.
• Traditionally, interest is not paid on current accounts and savings accounts earn minimal interest of about three per cent.
• Fixed deposits are relatively expensive to banks which pay between five and 10 per cent depending on the amount.

There is consensus, even among banks, that interest rates in Kenya are too high. The elusive question among stakeholders is: Who determines interest rates in the market?

If we look at the bigger picture, the monetary authority in charge of interest rates is the Central Bank of Kenya. This authority is conferred on the CBK by the Constitution. The interest rate is a fundamental factor in the promotion of price stability.

The banking sector plays a pivotal role in determining interest rates under the supervision or regulation of the CBK. The cost of money to banks is the interest rate that they pay on deposits.

Traditionally, interest is not paid on current accounts. On the other hand, savings accounts earn minimal interest of about three per cent whereas fixed deposits are relatively expensive to banks which pay between five and 10 per cent depending on the amount.

In terms of mix, current and savings account deposits comprise the bulk of the deposits offering and a cheap source of funds. Banks can also borrow long term funds from international lenders at relatively low rates of six to eight per cent.

In extreme circumstances banks turn to the CBK as lender of last resort. The rate offered by CBK is commonly referred to as the Central Bank Rate (CBR) which currently stands at 10.5 per cent.

Banks partly peg their rates on this rate. However, the rate is only indicative as the overall weighted cost of funds is much lower.

The rate is punitive and is meant to discourage banks from relying on CBK funds. Lenders are expected to source their funds from alternative markets.

It would therefore be misleading for banks to assume that the cost of funds is 10.5 per cent when it is relatively lower.
The cost of funds to banks on average is five to seven per cent, which they in turn lend to the public at between 18 to 24 per cent. The difference between the two is net interest revenue to banks.

The lenders also earn fees and commissions from customers. From this they pay salaries to staff, rent for premises and other overheads. The balance goes towards paying dividend to shareholders, investments and meeting CBK capital requirements. The question that arises is: Do banks charge excessively high interest rates therefore burdening the goose that lays the golden egg? In any case the goose is complaining.

The high rates discourage investment and entrepreneurship because few businesses make enough returns to pay back the funds.

Many Kenyans therefore resort to their savings, which take long to accumulate, to start reasonable ventures.
Paradoxically, this is the same money that attracts low rates when banked.

In effect is that this postpones investment and job creation. Borrowing from banks is supposed to bring about investment and consumption. High rates retard growth and accumulation of wealth.

They decelerate poverty alleviation and inhibit prosperity. This is not good for the economy and the society at large.

Anyone who does not support the greater good of the society is its enemy. Can banks claim goodwill in promoting societal good? The answer is simply No! The primary responsibility of the government

Will capping interest rates hurt banking? The answer is No! Banks must become innovative in cost reduction and moderate their appetite for profit for the greater good of the society.

In the short-term they will experience difficulties associated with the change, but ultimately they will prosper as the volume of business grows monumentally.

The reason against capping of rates given by banks is dishonest. Other countries have done it and succeeded. Banks say that Wanjiku will be denied funding as they will shy away from lending the high risk ordinary Kenyan.

Let’s be honest, Wanjiku is low risk. Has she ever brought down a bank? Who brought down Imperial and Dubai banks? Definitely not Wanjiku.

We have capped fuel prices, has it worked? It has. Would we have benefited from the decline in world fuel prices had cost not been controlled? Your guess is as good as mine.

We have also capped school fees in secondary schools and the Health ministry recently issued guidelines capping doctors’ fees, all for similar reasons. Banking need not be special in this respect.

Opposition to capping interest rates echoes the IMF and other international financial institutions’ stand.

The institutions must understand that our economic environments are different.

READ: Kenya Bankers Association's statement on new law

READ: Banks hit out at Uhuru's 'arbitrary' rate cap

Competitive edge

They should realise that as a country we support policies that promote our growth.

Why are foreign investors doing extremely well in our country? They source their funds at lower interest rates in their countries of origin.

High rates in Kenya give them a competitive edge and throw locals out of business. Would they then be pleased with capped rates? Of course not.

I wish to be counted with my professional body, the Institute of Certified Public Accountants (ICPAK), and all those who have shared this view in persuading President Uhuru Kenyatta to ascent to the Bill to bring down interest rates.

is to ensure prosperity among its citizens and any action that lends itself to this goal is be welcome.

To those opposed to the new law, it is a matter of time before our economy matures to accommodate a truly free market economy.

In the short-term, banks may have to swallow the bitter pill but they will in the long-term regain their health and together we shall prosper.

The author is a former banker. He is a lecturer and consultant in banking. jkabiru2@gmail.com