My column this week presents an article I wrote for African Banker magazine in the first quarter of 2020 about the impact of the repeal of Kenya’s interest rate cap law. At the time, African countries had not started to implement COVID-instigated lockdowns. With extraordinary measures now in place by most of the continent’s central banks to break the fall of their respective economies owing to the pandemic, the following allows an objective reflection on the state of Kenyan banks without any COVID-related bias. Of course, forecasts and ratings have since been reviewed mostly to the downside. But with the benefit of hindsight, it is astonishing how sunny the year looked back then.
In November 2019, about three years since Kenyan banks could only charge no more than 4 percent on the central bank’s benchmark rate (cap was instituted in September 2016) on loans to their customers, and after lamentations by key stakeholders and huge losses by banks, Kenya’s parliament finally repealed the constraining law. Not long thereafter, in late November, the Central Bank of Kenya (CBK) cut its benchmark rate by 50 basis points to 8.5 percent, having been constrained to do so hitherto due to the distortionary effects of the rate cap.
For instance, small and medium-sized enterprises (SMEs) were reportedly denied loans worth about 300 billion shillings, about 1 percent of GDP, during the period. Furthermore, credit extension to SMEs as a percentage of total bank loans fell to 15 percent in 2019 from about 25 percent before the cap was instituted.
Events leading up to the scrapping of the cap were not without some drama. President Uhuru Kenyatta refused assent to the initial version of the “Finance Bill 2019” that would have allowed the cap to remain. The Kenyan government was itself under pressure from the International Monetary Fund (IMF), which conditioned an extension of its standby credit facility on the repeal of the law. With the cap now scrapped, quite naturally, Kenyan banks, and indeed the economy, are expected to perform better in 2020. How well, though?
Events leading up to the scrapping of the cap were not without some drama. President Uhuru Kenyatta refused assent to the initial version of the Finance Bill 2019 that would have allowed the cap to remain
Stronger earnings and loan growth
Charles Robertson, global chief economist & head of macro strategy at Renaissance Capital, says the “[effects of the rate cap repeal] will start to show up in 2020 consumption and investment data [and] definitely should support growth – and help to compensate for a tighter government budget.”
George Mutua, managing director & chief representative officer, Kenya & East Africa at Societe Generale, agrees. “Kenya’s GDP growth, projected between 5.5 to 6 percent in 2020, would be driven mainly by increased credit growth, after the removal of the interest rate cap, as banks lend more to the private sector”, Mutua says. However, “banks will need to monitor non-performing loans (NPLs) closely to ensure they don’t breach acceptable thresholds on the back of [this] increased lending”, Mutua adds.
In December 2019, Fitch Ratings announced a positive 2020 outlook for Kenya’s banking sector, an upgrade from stable in 2019. The repeal of the loan rate cap in November 2019 is a major reason why, which Fitch believes “will allow banks to take control of their pricing policy and underwrite new business at rates more in line with borrowers’ risk profile.” Fitch also sees “improving credit conditions” enabling “banks to execute growth strategies.” In fact, Fitch expects over 10 percent loan growth in 2020, a continuation of the recovery in 2019.
“Kenyan banks received a huge boost in November when the lending rate cap was repealed by the government”, Mahin Dissanayake, senior director, Europe, the Middle East & Africa (EMEA) banks at Fitch Ratings, explains further in January. “We believe it will increase earnings and profitability on the back of loan repricing and stronger loan growth, with credit flowing back to key sectors like micro, small and medium enterprises and consumers”, Fitch’s Dissanayake adds.
In the same vein, Constantinos Kypreos, senior vice President, financial institutions, at Moody’s, says “removing the rate cap no longer constrains lending as banks are able to better price their risks without a rate cap”. “This will mean increased lending to segments of the economy that have had subdued growth and access to credit, primarily small and midsize enterprises”, Kypreos adds.
However, Moody’s Kypreos says he does not expect lending rates or profitability to return to early-2016 levels (banks’ return on assets declined to 3.4 percent in 2018 from 3.6 percent in 2017 and 4.0 percent in 2016); “given the authorities’ and banks’ focus on maintaining a low cost of credit”. Still, “Kenyan banks’ profitability will benefit slightly from loan and business growth [and] higher lending rates will increase net interest income, reversing the recent years’ trend of declining income and margins”, Moody’s Kypreos says.
Fitch’s Dissanayake shares a similar view. “Margins and earnings are unlikely to return to pre-cap levels”, Dissanayake says. “This is partly because banks have indicated that they might limit any increase in the cost of credit to customers and partly because the policy rate is 1.5 percentage points lower than [the] pre-cap [level]”, Dissanayake adds. But “the full/positive impact on profitability will be felt only over time.” “In addition, since it was introduced, banks have successfully grown non-interest revenues to compensate for lower margins.” Dissanayake says he believes “private sector loan growth will rise by around 10 percent in 2020.”
An edited version was published in the Q1 2020 issue of African Banker magazine
