IMF Sees Kenyan Bank-Loan Rate Cap Blunting Monetary Policy

  • Legislating borrowing costs doesn’t work, IMF cautions
  • New law seen hurting lenders with exposure to small businesses

Kenya’s decision to limit the rate that commercial banks can charge for loans will cloud the central bank’s monetary policy signals and may undermine efforts to keep inflation within the government’s target range, the International Monetary Fund said.

While the Central Bank of Kenya has been more effective in containing inflation over the past three years, “controls being introduced are going to blur the signals” that emanate from its interest-rate decisions, Armando Morales, the IMF country representative for Kenya, said in the capital, Nairobi.

“The central bank will need to go back to revise the arsenal of its instruments to see how they can offset this blurring of signals in the market,” Morales said in an interview Aug. 27.

Kenyan President Uhuru Kenyatta last week approved a law that placed a ceiling on the amount of interest lenders can charge for debt, and prescribing how much interest they should pay on deposits. Kenyatta, whose family owns a stake in the country’s closely held Commercial Bank of Africa Ltd., cited frustration with the high cost of credit and low returns on savings.

Wrong Solution

The impact of the new legislation won’t be “homogeneous”” as smaller banks may bear the brunt, Morales said. While Kenyans’ demands for lower interest rates are legitimate, instituting rate caps is the wrong way to solve the problem, Morales said.

“In our experience, using controls to lower the cost of financing has not been successful,” he said. “We think it doesn’t work.”

The law pegs credit costs at 400 basis points above the central bank rates and requires lenders to pay depositors 70 percent of the main lending rate. Kenyan banks extended loans at a weighted average of 18 percent in June, according to central bank data.

Policy makers held the central bank’s benchmark rate at 10.5 percent last month, after a 100 basis-point cut in May, as headline inflation accelerated to 6.4 percent in July from 5.8 percent in June. The central bank’s monetary policy committee may have to “revise some of its decisions” should inflation breach the target, he said.

Industry lobby group Kenya Bankers Association has warned that its members may find it difficult to implement the new law because it lacks important details including whether it applies to existing loans or new credit only. Lenders such as Barclays Bank of Kenya Ltd. and Co-Operative Bank of Kenya have said they will comply with the regulation.

Treasury Secretary Henry Rotich said Kenya still upholds free-market principles despite agreeing to legislate interest rates. Authorities in the $61 billion economy would work to improve market conditions that would make the law redundant, he said in an interview on Aug. 26.

“Obviously at some point, when the system becomes efficient, the solutions that had to happen will now be unwarranted,” Rotich said. “It’s not a backtracking in the liberal sense. We will push on that, but at the same time address the root cause of why interest rates are high.”

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