To Cap or not to cap? What does Kenya’s experience tell us about the impact of interest rate caps on the financial sector?

Rate of interest caps might have far-reaching effects around the composition and maturity of business loans from banks and deposits. From both an insurance policy and research perspective, you should comprehend the mechanisms behind such impacts and also the channels by which they affect various players within the financial sector.

While mix-country evidence shows that rate of interest caps can help to eliminate credit availability while increasing costs for low-earnings borrowers1, rigorous micro-evidence around the channels of impact inside an economy is missing.

Inside a new working paper that utilizes bank-level panel data from Kenya, Mehnaz Safavian and that i examine carefully the outcome from the lately enforced rate of interest caps around the country’s formal financial sector.2

In September 2016, the Kenyan Parliament passed an invoice that effectively enforced a cap on rates of interest billed on loans along with a corresponding floor around the rates of interest offered for deposit accounts by commercial banks. This latest legislation was as a result of the general public view that lending rates in Kenya were excessive, which banks were participating in predatory lending behavior. The eye rate caps were therefore intended to relieve the repayment burden on borrowers and improve financial inclusion as increasing numbers of individuals and corporations could borrow in the lower repayment rates.

So, what went down? Think about this snap statistic: in 2014, use of credit (as measured by development in credit towards the private sector) was 25% and, by December 2017, this slowed to two.4% the cheapest in more than a decade.

So precisely the complete opposite of exactly what the Kenyan government intended. Why?

To deal with this, you should first acknowledge the rate of interest caps weren’t enforced inside a vacuum. Once we describe at length within the paper, other factors were also playing, like the banking sector crisis of early 2016, the slowdown in loan growth and demand because of severe drought conditions, and also the political uncertainty connected using the 2017 general elections.

Because of other adding factors, we focus our analysis on identifying key microeconomic alterations in loan and deposit trends beginning 22 several weeks before the caps, and differentiate between your responses of business banks across different bank tiers and various kinds of clients.

Our analysis finds that that banks, tier 1, tier 2 and tier 3, demonstrated a substantial transfer of lending towards corporate clients at the fee for lending in other sectors for example SMEs, consumer loans, and new borrowers. Many of the notable since corporate clients already dominated the borrowed funds books from the banking sector, and also the caps appear to possess worsened that imbalance.

Within the situation of SMEs, which will make up over 98% of companies and supply 30% of new jobs in the united states, the economical results of a recession are harmful. Equally difficult, the proportion of recent borrowers receiving credit from banks considerably reduced by 50 plusPercent following a caps. These bits of information are in line with a September 2017 credit survey conducted through the Central Bank of Kenya, where 54% of respondents confirmed the rate of interest caps had negatively affected lending to SMEs.

Another victim from the rate of interest caps? Kenya’s savers, as there’s been a shift from interest bearing accounts to non-interest-bearing accounts. Our analysis confirms a substantial shift towards offering interest only on long term deposits and eliminating any interest choices on current accounts. This shift is most apparent among tier 3 banks where interest bearing accounts dropped precipitously to almost 0 % of portfolio as a result of the eye rate caps, lower from the previous average of 36%. These alterations in deposit composition are suggestive of the banking sector’s preference for maintaining their interest margins.

Overall, our analysis shows that the eye rate caps had important and unintended effects within the Kenyan economy. There are many policy alternatives that may both safeguard borrowers from excessive rates of interest and limit the negative effects of great interest rate caps. Included in this are wider adoption of credit rating through credit agencies so banks can differentiate lenders according to take more chances efficient loan property foreclosure procedures and movable collateral registries and greater focus on strengthening consumer protection measures through debt counseling and streamlined redressal mechanisms.

The Planet Bank has already been engaged using the Kenyan government bodies on a number of these alternative measures. With increased data that opens up, we’ll make sure to evaluate these policies at length and report on their behavior here with this results!

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