Entrepreneur Mungai Mwangi doesn’t have anything good to say about his experience borrowing from Kenyan banks. He almost closed his internet cafe business in 2013 after struggling to settle a loan from a local bank which he used to finance the cafe. The one-year loan had an interest rate of 18%. But, after he had made payments for six months, he learnt that his bank had covertly raised the interest rate on the loan to 24%, something that was a shocker to him and his business.
“I was angry and disappointed at the same time,” says Mwangi, who runs Bright Star Cyber Café. “I struggled a lot to repay the loan. I almost closed down my business, whose expansion I had funded with the loan.”
The frustration he faced has largely to do with a culture of predatory lending practices perfected by banks in the country over many years. Kenya’s president Uhuru Kenyatta alluded to such frustrations in support of his decision to sign the Banking (Amendment) Bill 2015 into law on Aug. 24. The new law, which has been in the making for sixteen years now, caps bank interest rates at 4 percentage points above the central bank’s benchmark rate.
The law also sets a floor for deposit rates paid to depositors at 70% of the benchmark rate. Before then, banks have been offering large depositors about 5% on their funds while charging borrowers at least 18% on loans. If the new rules are followed banks would pay depositors today a minimum of 7.35%.
In the past some commentators have described Kenyan banks as robbing their customers to reward shareholders. This might explain why investors have reacted negatively to the news. Kenyan bank stocks were down 6% on average last week, big names like Co-operative Bank and Equity Bank were down 23% and 22% respectively.
Small and medium enterprises, which are the bedrock of many economies, have been particularly negatively affected by the high cost of credit. Many are unable to compete in the export market due to the high cost of financing. Ciiru Waweru Waithaka, founder of FunKidz, a children’s furniture brand with global ambitions, is, for instance, irked by the fact enterprises like hers are unable to scale due to costly bank credit. This has diminished companies’ capacity to borrow and invest in appropriate equipment or technologies to enable them produce globally competitive products.
“Small businesses need to compete globally but for this to happen, the cost of borrowing should be affordable,” she tells Quartz. “Our products can compete on quality but sadly not on price, high interest rates being a factor. The cost of raw materials is high as a result of this too.”
Nothing better illustrates how borrowers have suffered at the hands of high lending rates than the $1.76 billion in bad loans Kenya’s banking industry reported at the end of March this year. The failure by banks to live up to their past promises to voluntarily lower lending rates may have prodded the president to sign the bill into law.
The first attempt by Kenyan lawmakers to rein in the exorbitant lending rates with a similar legislation happened in 2001. This failed. The second endeavor in 2011 was met with stiff resistance by banks. Bankers’ argument then was the regulation would choke the economy and obliterate gains made in the industry. The lenders made no secret the fact that they would turn away high risk borrowers and focus only on corporates, the government and a couple of low risk clients to do business with. Those considered high risk would be left at the mercy of even riskier alternatives such as loan sharks or unregulated microfinance institutions.
“Banks failed to live up to their promises and interest rates have continued to increase along with the spreads between the deposit and lending rates,” the president observed.
Arbitrary increases in rates have mostly made it difficult for borrowers to plan their finances and even impaired their businesses’ cash flow. Like Mwangi, many borrowers in Kenya and in many African countries have no love lost for banks.
Kenya joins at least 20 other African countries in deploying interest rate ceilings to protect consumers against extortionate bank rates. Zambia, which introduced a cap on commercial interest rates in 2013, removed the limits in November 2015 to allow for proper functioning of the credit market. The World Bank’s Consultative Group to Assist the Poor (CGAP) said in 2013 that in spite of the good intentions, interest rate caps can in effect hurt low-income populations by not only limiting their access to finance but also reducing price transparency.
But, with the law in place, commercial banks now appear determined to shirk high risk borrowers with formal credit uptake expected to shrink going forward. Speaking to local media on Aug. 25, Habil Olaka, chief executive of the Kenya Bankers Association, an industry lobby group, said that high risk borrowers will face a herculean task in an attempt to access bank credit.
“If your risk is higher than the 4% cap that is now in the law, it will be hard for a bank to give you a loan, most small and medium companies fall in this category and they are the backbone of the economy,” he said.
But, as one bank adjusted its rate to 14.5% on Aug. 26 in line with the new law, others said they are waiting for further guidelines from the central bank. When the law was passed, the widely held assumption was they would price loans in line with the central bank rate (CBR) currently at 10.5%. This rate is revised every two months. However, there’s the Kenya Bankers Reference Rate (KBRR), which the central bank revises every six months (as an average of the 91-day Treasury bill rate and the CBR) to guide banks when pricing credit. Banks use this as a standard base lending rate on which they add a premium and factor in their costs and margins. Bankers are also waiting for direction on whether or not the law will affect the existing loan contracts.
Yet, as ordinary Kenyans and small businesses don a celebratory mood, industry analysts such as development economist, Anzetse Were, are foreseeing the proliferation of shadow banks.
“I think there will be celebrations for about two or three months then people will start going to banks and realize that the banks are not giving them money,” Were tells Quartz.
“If someone realizes they don’t qualify for a bank loan because their risk profile is 20% and not 14%, I foresee a situation where there is going to be a very large shadow banking system that will be even larger than is the case now.”
Entrepreneurs such as Agosta Liko, founder of PesaPal, an online and mobile payments aggregator, seem to have seen it all as far as exposure to predatory lending practices is concerned. To build his business against all odds, he borrowed from different providers, including loan sharks, mobile and online lending platforms. As banks are restricted by the new law, platforms such as M-Shwari (a mobile money lending partnership between Safaricom and Commercial Bank of Africa, which is linked to president Kenyatta’s family) will continue to thrive by serving the high risk customers. M-Shwari charges borrowers 7.5% per month while loans on Tala (an online microcredit provider) attract a monthly interest rate of 15%.
“We can talk about (financial) inclusion, we can talk about changing people’s lives but we are just digital loan sharks,” Liko said at last month’s Quartz Africa Innovators’ summit.
Through his payments company, he is looking at ways of allotting credit scores to users based on data from PesaPal and other providers to help entities with positive scores to access loans at preferential rates.
“The problem that I think should be solved is, if someone pays their bills in good time and we can score our data and expose it to banks or financial institutions, then we should make it easier for them to get a lower interest loan,” he said.