Kenya's banks feel the pressure: Kenyan banks have welcomed the government's proposal to end interest rate caps, but the threat of new taxes is causing them consternation.

Author:Dzimwasha, Taku

Kenya's finance minister, Henry Rotich, surprised the country's banking industry in June 2018 when he announced as part of his budget that the government intended to scrap the interest rate caps imposed 22 months before.

The banks welcomed the U-turn because they claimed the caps were hindering credit growth and access. Section 33B of the 2016 Banking Amendment Act (BAA) capped the rate at which banks in Kenya could charge interest to 4% above the Central Bank of Kenya (CBK) rate. The CBK rate has remained stable at 9.5% since March this year.

The law also set the minimum interest a commercial bank depositor can earn at 70% of the CBK rate. The rate caps were introduced to end the practice of banks charging high interest rates for loans and to encourage Kenyans to save. However, they had the unintended consequence of causing interest earnings from loans to dip and commercial banks' loan books to shrink.

The banks have sought to mitigate these losses by aligning their businesses towards non-interest income, including fees and commissions, and government securities, according to Dannington Murage, analyst at Ecobank Capital in Kenya.

"Historically banks' earnings came mainly from loan activity, but after the interest rate cap came into effect, banks were unable to accurately price their risks ... Therefore, the banks slowed down their lending activity," says Murage. "Banks have ramped up their investment in government securities significantly in order to adapt to the current regulatory climate."

Investment in securities has reached unprecedented levels, growing by 6.1% in the first quarter of this year to KShi.09 trillion ($10.8bn), despite the fact that yields had been weakening in 2017. The continued investment in government securities in this environment indicates the high levels of risk aversion by banks in the face of the interest rate caps, according to Murage.

Hardest hit by the rate cap are the small--and medium-sized banks that make up half of the banking market share in the country.

These financial institutions are particularly vulnerable to industry shocks and have seen their earnings slashed. However, digital lenders offering micro-credit via mobile devices, such as KCB Bank Kenya and Commercial Bank of Africa (CBA), have proven to be resilient in the current difficult climate, says Murage. The micro-loans are between KSh1,000 and KSh5,000.

Uphill task

Despite the success of the micro-loan industry, the main banking sector...

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