KISERO: Which way for interest rates in Kenya?
1 weeks ago, 19:00
Interest rate caps can have far-reaching consequences on the composition and maturity of commercial bank loans and deposits. From both a policy and research standpoint, it is important to understand the mechanisms behind such impacts and the channels through which they affect various players in the financial sector.
While cross-country evidence suggests that interest rate caps can reduce credit availability and increase costs for low-income borrowers, rigorous micro-evidence on the channels of impact within an economy is missing.
In a new working paper that uses bank-level panel data from Kenya, we carefully examined the impact of the recently imposed interest rate caps on the country’s formal financial sector.
In September 2016, the Kenyan Parliament passed a bill that effectively imposed a cap on interest rates charged on loans and a corresponding floor on the interest rates offered for deposit accounts by commercial banks.
This new legislation was in response to the public view that lending rates in Kenya were too high, and that banks were engaging in predatory lending behavior. The interest rate caps were therefore intended to alleviate the repayment burden on borrowers and improve financial inclusion as more individuals and firms would be able to borrow at the lower repayment rates. So, what happened?
Consider this snap statistic: in 2014, access to credit (as measured by growth in credit to the private sector) was 25 per cent and, as of December 2017, this slowed to 2.4 per cent the lowest in over a decade. So exactly the opposite of what the Kenyan government intended.
But why?To address this question, it is important to first acknowledge that the interest rate caps were not imposed in a vacuum. As we describe in detail in the paper, several other factors were also at play, such as the banking sector crisis of early 2016, the slowdown in loan growth and demand due to severe drought conditions, and the political uncertainty associated with the 2017 General Election.
Due to these other contributing factors, we focus our analysis on identifying key microeconomic changes in loan and deposit trends starting 22 months prior to the caps, and differentiate between the responses of commercial banks across different bank tiers and different types of clients.
Our analysis finds that that all banks, tier 1, tier 2 and tier 3, showed a significant shift in lending towards corporate clients at the expense of lending in other sectors such as SMEs, consumer loans, and new borrowers.
Equally troublesome, the proportion of new borrowers receiving credit from banks significantly reduced by over 50 per cent following the caps. These findings are consistent with a September 2017 credit survey conducted by the Central Bank of Kenya, where 54 per cent of respondents confirmed that the interest rate caps had negatively affected lending to SMEs.
Another victim of the interest rate caps? Kenya’s savers, as there has been a shift from interest bearing accounts to non-interest-bearing accounts. Our analysis confirms a significant shift towards offering interest only on longer term deposits and eliminating any interest offerings on current ...
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