As per our Cytonn Weekly Report #33, we noted that the Interest Rate Cap Bill was one fuelled by anger and we went further to compare the Bill to Brexit a very populist move, fuelled by anger, but an equally unwise move that we may quickly regret; and just like Brexit, it came to pass, with President Uhuru Kenyatta on Wednesday 24th August signing the Interest Rate Cap Bill into law.
We were very surprised by the enactment; we did not think that the president would sign the Bill. But now that the Bill is law, this week we look at the effect of the Bill, what we expect going forward and what Kenyan banks should do to avoid any pitfalls.
As can be witnessed in any developed economy, free movement of goods and services is essential to correct pricing mechanisms, determined by the forces of demand and supply. Anytime there is external interference, such as with quotas or minimum wages, there is either excess supply or demand, and leads to a deadweight loss in the economy and ineffective allocation of resources. While many Kenyans may rejoice in lower interest rates, the truth of the matter is simply that there is an excess demand for bank credit, with financial institutions not willing to meet the demand at set prices.
The effect of signing the Bill was felt immediately within the financial markets:
- Banking sector stocks declined by 15.6% in 2-days of trading since the close of the market on Wednesday,
- Investors lost Kshs 88.9 bn in the same span of 2-days, highlighting the immediate negative impact of the decision on foreign sentiment towards the banking sectors future,
- Banks with large retail bases such as Equity Group and Co-operative Bank were the worst affected, both losing 20.3% and 20.6%, respectively, while the least affected counters were for CfC Stanbic and Standard Chartered, both losing 6.3% and 7.8%, respectively. It is quite clear that banks whose clientele are more inclined to retail and SMEs are bound to suffer more in this regime, given the high spreads they enjoy, and those that serve corporate clients will not be affected as much,
- A number of banks informed their clients of their intentions to do away with savings accounts, leading to a reduced number of attractive banking products in Kenya, and,
- Lending towards motor vehicles and providing unsecured loans was stopped by a number of banks.
In as much as we share the Presidents sentiments to increase affordability of financial products for the end consumer, such regulation of the main financial intermediary in the economy will only lead to more suffering of the bracket this Bill seeks to protect. The Bill is oblivious of other factors that affect pricing of loans and deposits such as risk profile, term structure of interest rates, cost of funds and macroeconomic variables. Furthermore, pegging it to the Base Lending Rate will depend largely on the transmission mechanism of monetary policy decision into the economy and the effectiveness of the Monetary Policy Committee in assessing the state of the economy. Though the monetary policy is gaining relevance, we are yet to see it a true pricing mechanisms for investors and banks, who have largely maintained their margins despite volatility in interest rates.
As stated in our Cytonn Weekly #33, several countries around the world, 76 to be exact, have put in place interest rate caps for various reasons but ended up with more problems to solve and eventually scrapped them off. We are of the view that capping interest rates might solve the high interest rate spreads in the banking sector, but what we expect going forward will be challenges such as:
- Locking out of SMEs and other perceived high risk borrowers from accessing credit, as banks will prefer to loan to the Government,
- Straining of small banks who effectively have been shut out from the interbank market and now have to mobilize funds at higher rates,
- Banks are likely to introduce bank accounts with zero interest features to bypass the minimum interest payable. For example, Co-operative Bank affirmed compliance with the 14.5% maximum rate on bank loans, but was silent on the minimum rate on deposits,
- Pricing will be opaque as the Bill is based on an unreasonable premise that the highest extra risk premium in the Kenya market is 4.0%,
- Banks may resort to colluding so as to push up the yields on the Treasury instruments, and find other ways of maintaining their margins, most likely at the expense of everyday savers who will be forced to move to current accounts, which carry zero interest features,
- Banks may resort to cheaper dollar funding, which will lead to a dollarization of the Kenyan economy, eroding all gains made so far in stabilizing the Kenyan Shilling,
- The emergence of strong shadow banking systems, which may result into inefficiencies in terms of transmitting the effects of monetary policy decision into the economy,
- Risk of job losses as banks cut jobs to maintain their cost base due to the lower margins, and
- Lower standards of living in the economy as the lower access to credit leads to a decline in both consumption and investment expenditure, reducing aggregate demand in the economy.
Below is a summary of the winners and losers from the Interest Rate Cap Bill. We will analyse the impact to the banking sector in detail in the upcoming banking sector report:
Summary of Winners and Losers from the Interest Rate Cap Bill
· Banks that lend primarily to the prime individual and corporate commercial segments because they have the most clients that can fit within the 4.0% risk premium. For example, Standard Chartered Bank
· Banks that lend primarily to the SME and sub prime segment because majority of their clients cant fit into the 4.0% risk premium. For example, Equity Group, KCB Group and Co-operative Bank
· Prime individual clients, because they will be highly sort after by the main stream banks since they will be seeking to bank prime clients, with assets to provide collateral
· Sub-prime clients because they will experience even most constrained access to conventional credit and will have to seek alternative & more expensive credit
· Corporate commercial segments because they will be highly sort after
· The SME sector since access to credit will be limited
· The government as banks will prefer to place money in Treasury instruments that are considered risk free
· The Kenyan economy, which is very reliant on SME sector. If there is less access to credit, the economy will register slow growth unless it adjusts very quickly by moving a lot of SME funding to the informal financing market
· Alternative finance and credit players that are outside the ambit of the amended Banking Act, 2015, since they can still price credit based on market dynamics
· Small depositors are likely to be pushed to no interest accounts
· Banks with multinational links as they can mobilize cheaper dollar funding from their parent company
· Government since banks will record low earnings, reducing their taxable income
The intent of the Bill was not to attack banks profitability but to protect the consumer from exploitation through unreasonable interest rates. We are concerned that those whom this Bill was intended to protect may end up being the biggest losers, with non-interest earning accounts and reduced access to mainstream bank loans such as bank unsecured loans whose pricing has to be way above 14.5%. We will monitor how the implementation unfolds, but so far banks have already eliminated some unsecured loans, emergency loans and motor vehicle loans.
Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.