Is capping of interest rates a zero-sum game?

BY KEVIN GIKONYO

A renowned scholar, Harry Markowitz, corralled the Management Portfolio Theory (MPT) in 1952. His empirical literature emphasised on diversification of risk and has been used in many settings. If you happen to be an Olympian in a javelin contest, for example, chances of making to the medal bracket are more when you make many attempts.

Many businesses that have become industrial giants have made a mark and survived from periodic income shocks due to the fact that they diversified their income streams. The likes of Samsung, LG, and Apple to mention a few, embraced this concept to the core and it has given them colossal returns. Locally, a classic reference resonates well with Safaricom’s market dominance as a mobile service provider company.

In early 2000 Kencell, now Airtel, opted to concentrate on the high-end market (especially by its per minute billing) thereby limiting its income stream to a chosen few. Safaricom, on the other hand, chose to diversify and tap as many customers as possible through agents, per second billing, data, and the now M-PESA money minting “technobank” mobile service.
The Kenyan Banking industry is no exception to this pace setting concept of diversification. The more customers, the more returns to shareholders. Equity Bank, the second largest bank in Africa, by customer base used the same theory to dominate more than a decade ago. It has recently posted Sh10.1 billion half year net profit ending July 2016, representing an 18% increase in profit compared to a similar period last year.

While the concept has been used almost to a “near-perfect” by Equity Bank, there is one bumpy aspect that seems to elude most players in the industry and has been subject to heated debates around interest on loans. This debate has been going on for years and has only maintained undertones and periodically resurfaced at eminence of economic contractions over the years. This year has been one of the toughest for businesses and for the first time in Equity bank’s history their loan portfolio shrunk by Sh6 billion to Sh269 billion.

Ms Waitherero of Standard Investment Bank (SIB) is quoted saying the shrink could be attributed to banks’ increase in choosing the quality of loans by lending to only those with good credit ratings. A keen look into the interest rates around the world shows Kenya’s average of 18.3% as one of the highest. The relation is somehow inversely related to developmental status of a country. With the most developed nations like USA, Switzerland, UK and Japan having the least interest rates on loans of nearly 2% on average.

An unforgettable look into the past, in 1993 for instance shows commercial banks in Kenya chocked its customers with high interest rates that skyrocketed to 35%, bringing most businesses to their knees. Auctioneers became a busy lot at the time and made a kill out of the misery of poor Kenyans who defaulted on loans. They defiled years of hard sweat for family businesses and companies. The major exodus to SACCOs happened during this period.

SACCO’s in Kenya have for the longest time charged 12% interest and have enjoyed a growing lending book with limited records to show exact figures due to the closed membership status that does not mandate them to make public their balance sheet results. Their Non-Performing-Loans (NPLs) are always low, since most members access loans against their deposits or group guarantors as collateral.

Equity bank redefined the loan space by commercial banks nearly a decade later by offering loans for as low as 13% giving to almost anyone who opened an account without the much stringent collateral requirements. As long as one could prove their capital venture is able to guarantee a steady income, they were eligible for a loan. However, that is slowly changing. Quietly, loyal members of the once vibrant Equity Building Society (EBS) are feeling the bank is slowly mutating into a ‘richman’s’ banks.

The journey to clamour for reduced interest rates on loan by Kenyans has always faded disgracefully. The blame for the status quo has always been placed on the movers and shakers of the economy that often has patrons in political circles. A case in history is the famous ‘Donde Bill’ of 1997, named after mover, MP for Gem. His Bill that sought to cap interest rates on loans was unanimously passed by Parliament but later on vetoed by President Moi on grounds that it subverted the ideology of liberalisation. Another Gem MP, Hon Jakoyo Midiwo, made a second attempt in August 2015. His proposal was declined on technical grounds that any amendment to a Finance Bill must have been debated by stakeholders before approval by the Budget Committee and subsequent tabling to Parliament, under rule 114 of the finance Bill.

At the end of last year commercial banks threw the economy into an interest spin again of close to 30% on personal loans.

On July 27, Kiambu town MP Hon Jude Njomo proposed a Bill to cap interest rates yet again at 400 basis points above CBR (Central Bank Rate) currently at 10.5%. In addition, the bill proposed that banks give an interest on deposits of not less than 70% of the CBR, meaning banks will be forced to operate on a certain bracket margin based on CBR. The Bill was unanimously passed on July 28 in a bid to reintroduce capping of interest rates on loans. CBR is usually determined periodically by a Monetary Policy Committee (MPC) within the central Bank, chaired by the Central Bank of Kenya (CBK) governor. MPC usually factors the country’s inflation, major foreign currencies exchange position, monetary and fiscal analysis and global economic effects on Kenya in order to establish the value of CBR.
Amid immense public and political pressure against that of his personal interest and those of the commercial banks, President Kenyatta assented to the Bill on August 24.

“This is the third time that the National assembly is attempting to reduce interest rates to affordable levels. In the previous instances, dialogue and promises of change prevailed and banks avoided the introduction of these caps. In those instances banks failed to live up to their promise and interest rates have continued to increase along with spreads between deposits and lending rates” said the President in a well-crafted public statement that also sought to give the downside of capping interest but assured that his administration will closely monitor the volatility of the monetary effects of the law.

The financial services in Kenya is second to none in Africa, according to Brookings Financial and Digital Inclusion report that evaluates access to and use of affordable financial services. Brookings institution, a U.S based non-profit making organisation in Washington DC does global research on economic, education and governance in domestic and foreign policy development. Most Kenyans feel the banks are making super profits and their only rush is to grow and compete amongst themselves. A snippet data for last year shows a combined pre-tax profits for banks at a staggering Sh134 billion in the 12 months through December and if this year half results are anything to go by, these figures could be in excess of Sh160 billion by end of the year. At the height of all these accolades, Kenyans still believe that commercial banks are a preserve of the working, middle and top income earners in the country. They rarely support start-ups and kill the dreams of many young Kenyans even before they leave their beds of innovation and entrepreneurship.

For most banks, you have to provide six months statement, valuable collateral or show proof of a steady employment income before you access any loan. The bigger share of the mass is left to the whims of government fronted loans schemes like Uwezo fund or SACCOs, and shylocks presently operating online where the later usually charges very high interest rates of up to over 100% per annum.

The current debate, in my view, is an advertent cry of accessibility to loans rather than of high interest rates. The credit access bar has gone to another level with growing information sharing by the credit reference bureaus whose ones adverse listing leads to an outright lockout from mainstream lenders into the dungeons of hungry shylocks. The argument to reduce interest rates is as divergent as the proponent and opponent’s personal attributes, more like the chicken and the egg analogy.

Commercial Bank of Africa, the largest in Africa by customer base has a unique partnership with Safaricom’s M-shwari platform. It registered the greatest jump in its loan book by close to 305% from Sh7 billion to Sh23 billion over the same period last year. Accessibility of these loans over the mobile phone is amazingly fast at 7.5% p.m. Mathematically, this translates to a 90% interest rate per year. Surprisingly this is indifferent to customer’s decisions and they would rather rush to get these loans from the comfort of their homes and less stringent requirements. This would essentially mean loans offered by CBA through M-shwari platform are the most expensive formalised loans in the industry at 90% p.a. and are not encompassed in the new law which only targets mainstream banking.

It is also true that interest rates are inversely related to a lender’s income, proportionate to the quality of loans and a function to accessibility of loans. Family Bank, whose interest was the lowest at 14.8%, for instance, grew its interest income by 34% to Sh6 billion, but declined its profits by 40% to Sh711.5 million compared to a similar period last year. These profit margins were eaten away by increased Non-Performing Loans (NPLs) that grew eightfold to make the provision for bad debts hit Sh299.3 million thereby increasing its operating expenses by 30% to Sh3.8 billion. Hence the less your interest rate the more interest income and in order to sustain the proportional benefits then banks need to innovate and develop policies that will increase the quality of loans.

With 43 banks, 12 Deposit taking Micro-finance, 30 Credit only Micro-finance, 199 Saccos, 5 Mobile money operators and 3 Credit reference agencies, Kenya is well placed to enhance a more robust financial inclusion above the current 75%, one of the highest ratings in the world and the first in Africa. To the contrary, there has been too much inefficiency, too much money idling in capital, that it created a ‘devil’s workshop’ in finding ways to use it including insider lending.

These have since seized with the new ‘sheriff’ in town, CBK Governor Njoroge who is operating in full swing sending bank executives into panic mode in order to meet the previously ignored regulatory requirements. Some allege Mr Njoroge has gone-slow on his aggression because the expose on Banks’ anomalies were enormous and periodic surveillance was a compromise away from the public glare to avoid capital flight. Insider lending in family owned banks, unnecessary system upgrades and unregulated provisions for bad debt were used to hide the true position of most banks.

Most shocking was the use of parallel systems at National Bank of Kenya that led to massive siphoning of funds, even by junior staff. This is according to one Wanjiru who, for fear of victimisation we cannot reveal her full identity. She was among the staff who noticed the anomaly way before the interdiction of its executives. This practise made the unaccounted for insider lending at Imperial and Chase bank look like Child’s play and of course the government will always come to its rescue at the expense of taxpayer’s money.

Banks’ shareholder and owners have often placed high targets to the executives to increase profits by as much as 20% every year. One of the tier one banks CEO was tasked to increase profit volumes by more than 25% a year. The low hanging fruit was to drastically increase ledger fees by more than 200% while issuing a short notice to customers who had no option but to swallow the bitter pill. These figures would amount to millions of shillings and a part-in-the back at end of year in form of bonuses would allow these executives to lavishly buy beach houses along the Mombasa coast on cash transactions basis at the expense of customers and overly strained junior employees.

Most junior employees work more than ten hours a day to the ignorance of unions and banks association that play to the piper’s tune. This pressure is so real that it has degenerated into drastic measures to reduce wage cost in order to increase profits by giving early retirement to youthful staff.

With the new law, banks need to adjust into new frontiers of ensuring ultimate efficiency on capital and utmost generation of income. Tier 2 and below have to employ techniques of diversification faster than their tier one counterparts. These forms of diversification could be employed through a myriad of ways, for instance by; Geographical coverage, where technology can be used to bring a closer access to banks services and use of national agents in order to increase their ease of access to service; New sources of income for instance banc assurance and investment banking; Product and Services, for example by broadening the types of loans to include intellectual property or innovations funding;

Economic Sector, where a move from the conventional industry players will be beneficial and a specialisation on such sectors could lead to loyalty since there will exist an indifferent cost on loans and; Sources of Capital, where use of corporate bonds and other cheap instruments of capital will ensure banks are able to sustain reduced loan interest margins.
Tier one banks will have an easier ride ahead since they will be able to fund other sources of revenue. The smaller banks would fall back to reducing the risk on loans and engage in more government securities. This may stifle access to loans. Mergers, acquisitions and take-overs may be inevitable to some banks as interbank lending may soon become a high cost to maintain in order to meet their daily liquidity ratios. Kenya is still considered overbanked and bigger economies in Africa like Nigeria have fewer banks supporting their financial system.

The Eureka moment for Kenyan commercial banks lies in making sure loans are accessible as much as possible, to as many people as they can following Markowitz theory of diversification. These techniques have so far been perfected by shylocks who enjoy massive returns from already locked out non-capitalised populace. Commercial banks need stringent policies to enhance borrower’s accountability, recovery and collection techniques to avoid a growing book of defaulters and allow increased loan assets. It is better to loan ten people with Sh100, 000 each than one person with Sh1 million in order to reduce the cost of NPLs. It is working with CBA, Equity Bank and KCB already.

The biggest gainers will be the corporates, SMEs and salaried Kenyans who will be able to access loans easily and cheaply as competition amongst banks to offer quality loans takes shape. Those away from these brackets may find it hard to access loans in the interim and an economic ripple effect maybe their mid-term benefit.