Here’s what recent credit market changes means to you

With the interest rate cap repealed, financial market expects an increased access to credit by borrowers that have been shunned under the current regulated loan-pricing framework going forward as well as increased Net Interest Margins (NIMs) due to higher yields on interest-earning assets coupled with a reduction in the cost of funds following the removal of interest rate floors in 2018, that required banks to pay lenders at least 70.0 per cent of the base lending rate.

This has seen deposit rates hit a 36-month low in September 2019, to stand at 4.6 per cent compared to 6.3 per cent in September 2018 as lenders continue to ride on cheaper deposits.

Kenya’s President Uhuru Kenyatta last month (November) signed into law the Finance Bill 2019 after the bid to remove a cap on commercial lending rates was passed in Parliament following a quorum hitch, potentially boosting the flow of credit to the economy and return of expensive credit.

The removal of the cap however, had stoked fears that banks could return the lending rates that prevailed ahead of introduction of the law that restricted bank loan charges.

In the amendments to the rate cap legislation, legislators shielded existing loans from higher interest rates once the cap is repealed, meaning that only new loans will be affected by the high interest rates set to follow.

The enactment of the Banking (Amendment) Act 2015 in September 2016, that capped lending rates at 4.0 per cent above the Central Bank Rate (CBR), and deposit rates at 70.0 per cent of the CBR, came against a backdrop of low trust in the Kenyan banking sector due to various reasons:

The total cost of credit was high at approximately 21.0 per cent yearly per cent, yet on the other hand, the interest earned on deposits placed in banks was low, at approximately 5.0 per cent annually.

Calls for capping interest rates were based on the high profitability in the banking sector because of high spreads between lending rates and deposits rates, which in 2016 was at a high of 9.5 per cent. As a result, in 2016, the Return on Equity of Kenyan banks stood at 24.5 per cent above the 5-year SSA average of 15.4 per cent. The Return on Assets, on the other hand, stood at 3.1% above the 5-year SSA average of 1.5 per cent.

The period was marred with several failures of banks such as Chase Bank Limited, Imperial Bank Limited and Dubai Bank, due to failures in corporate governance. The failure of these banks rendered depositors helpless and unable to access their deposits in these banks, leading to public sentiment that something had to be done to the banking sector.

Private sector credit growth in Kenya has been declining, and the enactment of the Banking (Amendment) Act 2015, had the adverse effect of further subduing credit growth. In the first year following the introduction of the interest rate capping, the stock of credit to MSMEs declined sharply by 10% y/y on account of difficulty for banks to price the SMEs within the set margins, as they were perceived “risky borrowers”.

Banks thus invested in asset classes with higher returns on a risk-adjusted basis, such as government securities. Lending to the public sector increased sharply with a growth of over 25% y/y over the same period.

Private sector credit growth touched a high of 25.8% in June 2014, and averaged 11.0% over the last five-years, but dropped to below 5.0% after the implementation of interest rates controls, rising slightly to 6.3% in August 2019. The chart below highlights the trend in private sector credit growth.

As a result of the private sector credit crunch, there was a rapid rise in the alternative credit markets as evidenced by the Mobile Financial Services (MFS) rising to become the preferred method to access financial services in 2019, with 79.4% of the adult population using the channels, up from 71.4% in 2016. According to Global Digital, in 2018 there were about 6.1 mn digital borrowers in the country coupled with 28.3 mn unique mobile users.

Players in this segment charge exorbitant interest rates, e.g. M-Shwari charges a facilitation fee of 7.5% on amounts borrowed, and an interest rate of 90% when annualized, while Tala and Branch offer varying rates depending on the repayment period with a month’s loans offered at a rate of 15.0%, and the annualized rates vary between 132% and 152%. While the immediate effects of these alternative channels have been predatory, we believe that the investments and progress made in developing the alternative channels will have positive long-term impact as an alternative financial services channel once the sector becomes regulated.

The introduction of interest rate controls has made it difficult for the CBK to adjust the monetary policy rates in response to economic developments. Before the interest rates were capped, the CBK was able to adjust the Central Bank Rate (CBR) in relation to changes in inflation and growth. This is mainly because any alteration to the CBR would directly affect credit conditions.

Expansionary monetary policy is difficult to implement since lowering the CBR has the effect of lowering the lending rates and as a consequence, banks find it even more difficult to price for risk at the lower interest rates, leading to pricing out of even more risky borrowers, and hence further reducing access to credit. On the other hand, if the CBK was to employ a contractionary monetary policy, so as to reduce inflation and credit growth for example, then raising the CBR would have the reverse effect of increasing the supply of credit in the economy since banks would be able to admit riskier borrowers.