This archive report was first published on 5 November 2019.
Why Banks Are Salivating on Interest Cap Removal ¶
Published on November 5, 2019, local banks' bid to have the interest cap on loans removed seems almost a done deal. However, experts argue that the cap was necessary to curb high interest rates.
According to a writer who teaches at the University of Nairobi, the problem is not the interest rate itself but how businesses package their loans. 'Interest rate is an issue when debt capital is used to finance the business,' they explain.
Those businesses that avoid debt by using equity capital to finance their assets avoid financial risk. They do not have to worry about fluctuations in interest rates. Managers must decide on whether to use debt capital, and it is not advisable to use debt when interest rates are too high and the economy is in a recession.
Parliament imposed a cap on commercial lending and borrowing rates in 2016, and most businesses other than banks supported that action. At that time, the cost of credit was too high, with some banks charging interest at the rate of 25 per cent.
The genuine criticism against the cap then was that it was arbitrary and that inadequate research was done to identify the interest rate that supports our target economic growth. In developed economies, it is the Central Bank that caps interest by setting ceilings and floors of interest rates.
Well-informed economies do not put macroeconomic indicators such as the level of interest rate to a vote in Parliament. They leave such decisions to bureaucrats and the regulators. The major undoing of interest rate capping was the inherent assumption that money is lent to individuals and not to projects.
Even the reason that banks advance to support rate cap removal is not supported by their actions. Banks should have lowered the borrowing interest rate to as low as five per cent to signal their support to businesses. Instead, the banks claim the removal of the rate cap is necessary so that they can charge small businesses high interest.
How can someone help you by increasing your cost of doing business? Why is it that in the US, the basic interest rate is between 0.75 per cent and 1.5 per cent, such that if one borrows Sh100,000, the basic interest will be Sh1,500 compare to Kenya's Sh9,500 on the same cash?
The other negative aspect of capping the interest rate is that it interferes with the monetary operations of the Central Bank, meant to ensure that changes in the interest rate reflect changes in the business cycle and inflation.
Managers must generate internal revenue to reduce their reliance on bank capital. Increased number of goods and services being produced translate to higher income and retained earnings that can finance a firm's growth.
Many people have had their assets auctioned due to a bank loan. 'An effective interest rate regime turns citizens into savers instead of driving them into bankruptcy,' the writer concludes.
