Interest cap to squeeze small lenders harder

Large banks will protect their profit margins by pushing more loans if capping of interest rates is introduced, an international rating agency has said.

Fitch Ratings noted large banks would be better placed than their smaller rivals to deal with the sharp reduction in net interest margin.

“Large players, with stronger franchises and more diverse business models, should be able to attract new business and, with greater volumes, offset some of the squeeze on profitability,” said the rating agency.

The country has seven large lenders which control more 58 per cent of the banking sector taking home 70 per cent of the industry profits.

Large banks are able to source for cash cheaply but still charge the same prices as small lenders allowing them to enjoy huge interest spreads.

The Bill, which is currently before President Uhuru Kenyatta who has the option of signing it to law or sending it back to Parliament with a memo, proposes capping of interest rates at four per cent above the indicative Central Bank Rate (CBR). It also sets the floor for deposit rates at 70 per cent of the CBR.

If President Kenyatta signs the Bill into law in the current environment, bank lending rates would be capped at 14.5 per cent based on the current CBR of 10.5 per cent.

That would be significantly different from the prevailing average lending rate of 18 per cent, as per CBK data, with some borrowers paying up to 24 per cent.

The sudden drop is likely to fan an appetite to borrow, which large banks can ride on to grow their volumes.

Bankers are, however, opposed to the Bill arguing it will make it hard for them to price the risk of default forcing them to lock out all borrowers perceived as risky, a position supported by the rating agency.

In other countries where controls have been introduced banks have kept off riskier business segments.
“South Africa recently introduced a rate cap on unsecured consumer lending, which has led to a retrenchment from this segment by some banks,” said Fitch.

Bad loans in the banking sector are currently at Sh172 billion which is 8.2 per cent of their total loan book.
The immediate impact of the signing will be a slash to the wide interest margins enjoyed by banks.

Currently, interest spreads in the country average 11 per cent, which has been termed as high by local and international experts.

Banks have not heeded calls to cut lending rates prompting the formulation of the proposed law that is seen as the only way to tame them as they continue to post huge profits while the rest of the economy struggles.

Those opposed to the Bill note that banks may introduce higher charges and fees in an effort to protect their profits.

There are also fears banks will turn to lending their money to the National Treasury denying the productive private segment of the economy funding.
Currently, banks are holding 54 per cent of issued Treasury bills and bonds worth an estimated Sh647 billion.

MPs have promised to raise the two thirds majority required to quash a presidential decision rejecting the Bill.