Editor’s note: On 24th August 2016, President Uhuru Kenyatta assented to the Banking (Amendment) Bill, 2015.
I’ll admit to not being the most knowledgeable about the economy. Sure, back in the day when I was a pupil (LOL at that statement, since I was but a pupil only until 3 weeks ago), I had developed quite an interest in commercial law. I could explain the law and the legal principles behind it, but the real figures, the whys and wherefores were all Greek to me. This is why I had lunch with The Secret Economist (TSE) at the local kibanda in an undisclosed location to demystify the Banking Amendment (Bill) 2015.
OD: Welcome to the first ever Lunch with Obiter Dicter.
TSE: Thank you.
OD: What do you think about the Banking (Amendment) Bill, 2015? The proposed Section 33B seeks to set the maximum interest on loans given by banks and financial institutions at four per cent above the base rate published by the Central Bank of Kenya (CBK). What do you make of this?
TSE: I’m all over the place on the Bill to be honest. On one hand, I think we need to shock our banks into sanity; on the other hand, electroconvulsive shock therapy hasn’t had quite worked that well before. The Bill seeks to make credit more affordable to the public but its potential impact could go well beyond the banking sector into the real economy. And the last thing the markets need now is more uncertainty…
OD: But hold on a minute, hasn’t it worked before? I mean, we have capped fuel prices to curb the cartel-like behaviour of oil marketers, with varying degrees of success, and failures. Mostly failures.
TSE: Apples and oranges, apples and oranges. Regulating the price of commodities such as fuel and sugar is quite different from regulating the pricing of credit.
OD: How so?
TSE: Well, the price of credit is a factor of many variables. Credit risk, market risk, inflation, operational costs, capital provisions etc. There’s a reason why Kenya Airways is still in operation with a negative equity position in excess of Kshs 30 billion whereas a bank with a Kshs 10 billion funding gap is immediately placed under receivership.
OD: Others have said the Bill is purely a populist move for political reasons.
TSE: Well, it’s one of those political promises that you don’t really think about until it comes back to bite you in the ass. Let’s look at the politics. The President is damned if he signs and quite damned if he doesn’t. The Jubilee Manifesto explicitly talked about lowering interest rates…
OD: But they also talked about five world-class stadiums…
TSE: And free laptops for every child. But anyway, given the timing of the Bill, it’s one year to an election, the government must show that it’s done something to lower rates. Or at least show they didn’t shoot down the mwananchi’s only chance of ever having lower interest rates. When the Bill was proposed last year, I was very confident that it would collapse before the Second Reading. I could have put quite a chunk on Sportpesa. In hindsight, I shouldn’t have.
OD: Speaking of which, what’s the effective rate? The Bill only mentions a base rate set and published by the CBK, which publishes both the Central Bank Rate (CBR) and Kenya Banks’ Reference Rate (KBRR). Which one do you think will apply?
TSE: You’re the lawyer. You guys can twist words and say I was misquoted. The base rate is normally used to refer to the CBR which is the main monetary policy instrument of the Central Bank. Even the KBRR is set in reference to the CBR.
OB: What is the real problem according to you?
TSE: The truth is that banks are running a very simplistic business model. When you apply for a loan in Kenya, you are given a loan schedule with pre-determined rates and repayment periods to which you tailor your needs rather than the other way round. This is not banking, it’s shylocking.
OD: But the Bill seems to cure that. I mean, look at the proposed section 31A which requires that a bank or financial institution should disclose the charges and terms of the loan. In effect, this Bill seeks to lower the rate of usance.
TSE: I see what you did there. A second Daniel. Honestly, everyone agrees that lending rates and banks’ profits are too high in Kenya, the problem in my view lies elsewhere. On a macroeconomic level, Kenya isn’t doing too shabbily. The economy has been very stable over the last 15 or so years.
OB: You’re the stats guru…readers want facts and figures. They’re not going to believe me when I say the economy is doing well.
TSE: Bouts of volatility like 2008, 2011 and 2015 while significant, were still well below levels seen in peer countries. The Kenyan shilling depreciated by 12%. However, this is nothing compared to almost 30% levels seen in South Africa, Tanzania and Uganda. On the corporate side, the same stability and resilience is unheard of, save for Safaricom. Look at how the listed companies on the NSE are performing. Profits are going down like Gotti in the DM.
OD: But this isn’t happening to banks, I guess…
TSE: Banks in Kenya earn net interest margins (NIMs) of around 9% with non-performing loans (NPL) averages of about 5%. The return on equity (RoE) is staggering. It’s above 20%, given that over the same time NPLs on the lending side have reduced from 30% to 5% (and 8% now). In sane economies, the spreads earned by banks should reflect the underlying risk on lending. Average NPLs should be a good indicator of this.
OD: Hold up, hold up, let’s talk in English. What’s a spread? Is it like Blue Band?
TSE: Spread refers to the difference between the bank’s yield from loans and the rate it pays on deposits. It’s like profit, but sounds better when you say spread…take for example, if the Bill were to be adopted today, banks would issue interest to depositors at 7.35% and lend at 14.5%. That’s a spread of 7.15%. However, most banks’ current spreads are anywhere between 8-12%. Compare this to 4-5% averages elsewhere.
OD: Oh, okay. Go on…
TSE: For a country of 40 or so odd banks, we’ve had more than 23 banking failures over the last 20 years. Therefore, to the average depositor, the probability of a bank’s collapse is above 30%. Maybe we should be the ones asking for a premium for depositing money with banks, instead of banks charging a premium on lending to us.
OD: But the Governor of the CBK has been throwing words like “moral suasion” around. Is it feasible? (Moral suasion refers to the practice of the CBK persuading commercial banks to make decisions or follow certain paths to achieve a desired result like changes in the level of credit to specific sectors of the economy).
TSE: The CBK Governor has been quite ahead of the curve on this and therefore sought to slowly introduce differential credit scoring metrics in all banks.
OD: Uh, what’s that? I thought we agreed to have a conversation in English…
TSE: Different rates for different borrowers. Take for example, a 35-year-old, with a family, say, one child servicing a mortgage. How does that person borrow at the same rate as a 25-year-old who’s borrowed to buy a Subaru? The banks should adopt the model used by insurance companies; riskier drivers pay higher premiums. So should risky borrowers. What’s the point of having credit reference bureaus (CRBs), sharing information and flagging defaulters, yet that information isn’t used to reward creditworthy borrowers with a good repayment history? Plus, look at it this way, we have mobile banking, agency banking, services which have reduced the banks’ operating costs, yet these benefits are not trickling down to consumers.
OD: So how does the CBK get into all this?
TSE: The CBK took it upon itself to push banks to lower lending rates and thus obviate the need for legislation on the same. But banks, being too comfortable in the status quo just ignored the hints.
OD: How so?
TSE: The CBK maintained the KBRR at 9.87% in January even though the market and fundamental dictates required it to be revised upwards to reflect the tightening monetary policy stance prevailing at the time. In May, the CBR was lowered by 1% to pave way for lowering the KBRR in July. In my estimation, this was earlier than fundamentals would have warranted, such as the impact of Brexit and the uncertainty over whether the Federal Reserve would hike interest rates (they didn’t). Unfortunately, lowering both the CBR and the KBRR was in vain as banks refused to offer the trickle-down effect to borrowers that he was asking for. Instead, they took advantage of the opportunity to increase their margins and boost profitability in the second quarter of 2016. You can see banks releasing their Q2 results and the numbers show this.
OD: How do you think this will play out?
TSE: I think the President is cornered and as such he has to engineer a way out of the dilemma without assenting or vetoing the Bill. The pressure on him to veto the Bill is immense, but to do so he would need to ensure there’s a better solution from “the experts” first so Kenyans can have someone else to blame should it fail.
OB: Was the Memorandum of Understanding presented to the CBK by the Kenya Bankers Association (KBA) such a move?
TSE: Oh, you saw that.
OD: Everyone saw that. Last kicks of a dying horse?
TSE: The CBK/KBA presser was probably just a move to buy time for the President to push for sterner measures than those proposed by banks. It’s like House of Cards. Funny enough, in their MoU through KBA, banks pledged to adopt these same models within one year. One year. That’s like a dead-beat dad promising to start supporting his kids who’ve already hit puberty within one year. Like fam, you woke up one morning and decided to support your family. Where the hell you been for the past 12 years?
OD: This is not an interview by the way. It’s a discussion.
TSE: Oh, I never knew lawyers had that. All right, what’s the legislative history of this Bill?
OD: Well, capping interest rates is something we’ve tried before. Joe Donde, MP for Gem wished to amend the Banking Act with quite similar provisions to the 2015 Bill back in 2000 . Interest was to be capped at 4% of the 91-day Treasury Bill rate as published monthly by the CBK. Interest on deposits were to be a minimum of 70% of the same T-Bill rate. But you know, bankers and lawyers just had to meddle. In 2011, a similar attempt was made by Martin Ogindo, then MP for Rangwe. Jakoyo Midiwo, Donde’s successor in Gem, tried a similar thing just last year by attempting to amend the Finance Bill, 2015. This time, it was the Parliamentary Budget Committee that was not consulted. Now the words on everyone’s lips are Jude Njomo.
TSE: I heard there’s a class action suit on this issue, if I’m not wrong.
OD: Yeah, but it’s on a different but somewhat related matter, on whether banks need the approval of the Minister to vary interest rates as per section 44 of the Banking Act. Rose Florence Wanjiru v Standard Chartered Bank of Kenya Limited & 2 others has the potential to be the greatest law suit in the history of Kenyan commercial law. I mean, when the court allowed every Tom, Dick and Harry who has ever been royally screwed over by a bank to join the class action suit, you’re looking at quite a plaintiff list. Of course banks have fought that decision all the way; from the High Court (they won and the suit was dismissed), to the Court of Appeal (they lost, when the appellate court held that it was wrong to dismiss the suit in its entirety), which also refused to certify the matter as one of great public importance which would warrant an appeal to the Supreme Court. The banks appealed to the Supreme Court anyway, and lost, again. Banks are taking Ls all over.
TSE: Except on the bottom line.
OD: What are the short-term, medium-term and long-term effects if the Bill is assented to? Just asking…
TSE: It’s a realistic gamble that could regulate a rogue banking sector which operates like a cartel and charges customers for their own inefficiencies, but it will be inefficient in the long run. On the balance of risks I’d have to say it’s ill-advised, a bit like putting Trump in office. We have to be realistic here. In as much as these people need to be reined in, no amount of legislation would change a poor operating model.
Capping rates at 4% above CBR seems like a genius move now, but given that the main aim of the CBR is to tame inflation and maintain the shilling’s stability, what happens when the rate hits 18% like it did in 2011? Or even higher like 26% in Ghana and Malawi? According to me, the CBR is too short-term, too subjective and too responsive to global sentiment to be reliably used to set lending rates. Doing so would mean every time the Fed or the People’s Bank of China sneezes, the Kenyan economy catches a cold and ultimately the borrowers suffer; not to mention the ripple effect on monetary policy. Investors do not like interest rates that yo-yo on whims, but they hate interest rate caps.
OD: So, is this one of those victimless crimes in Kenya with no solution? Do we just forget and wait for the next scandal?
TSE: There’s been a lot of literature on high NIMs in developing countries for a long time, meaning that it’s not just a Kenyan problem. The problem of high spreads has always boiled down to 4 main issues:
- Macros: Operating in developing countries like Kenya has always carried with its own unique risks and costs, for example, the post-election violence, a rent-seeking political class, complex tax systems, structural bottlenecks… All this investment in infrastructure we’ve been doing is starting to pay off, the economy is growing and resilient and costs of doing business are coming down. Banks should start passing these benefits to customers.
- Information asymmetry: Banks’ inability to ascertain borrowers’ risk-worthiness and the high cost of doing so reliably remains a challenge. This leads to banks compensating by charging high rates for loans and adverse selection where bad borrowers are more likely to apply for loans, pricing good borrowers out of the market. Enhancing the role of CRBs and a single collateral registry (as contemplated in the Movable Property Security Rights Bill, 2016) could go a long way in addressing this.
- High operation costs: High overheads and costs for opening up new branches. Kenya is well ahead of its peers here. Agency, online and mobile banking have significantly reduced operating costs for banks. Kenyan banks are among the most efficient banks (cost-wise) in the developing world and as such the Kenyan customers should enjoy the benefits.
- Market structure: This is more of an issue of imperfect competition where we have many banks and little competition. The classic water everywhere but not a drop to drink scenario. Banks just charge high spreads because they can (In Economics, we call them monopolistic rents). This is what the Bill seeks to regulate, but I think the CBK is better placed to do this through more market-friendly means.
OD: Thank you very much. Lunch is on you, by the way…
TSE: Lawyers. And I thought bankers were the problem.