Wananchi Opinion: Central Bank of Kenya Should Revert to Interest Rate Caps on Loans

By Abol Kings

Interest rates play a pivotal role in the economic stability of a nation. In Kenya, the debate surrounding the capping of interest rates charged by commercial banks has been contentious.

Between 2016 and 2019, the Kenyan government implemented a law to cap interest rates at four percentage points above the Central Bank Rate (CBR).

While the policy was repealed, citing its negative impact on credit access, the argument for reintroducing interest rate caps remains compelling. Arguments in favour of reinstating the interest rate cap policy are as follows:

Protection of borrowers from predatory lending practices. In Kenya, commercial banks have been known to charge exorbitant interest rates, sometimes exceeding 20% annually.

These high rates disproportionately affect low-income earners and small businesses, which often rely on loans to meet their financial needs.

Without caps, lenders have greater latitude to set rates that prioritise profitability over consumer welfare.

Interest rate caps act as a safeguard against exploitation, ensuring that banks operate within reasonable margins.

For many Kenyans, particularly in rural areas, loans are not merely financial instruments but lifelines for survival and business growth.

Reintroducing caps would ensure that these borrowers are not subjected to crippling debt burdens, thus fostering financial inclusivity and social equity.

Encouraging economic growth. Small and medium-sized enterprises (SMEs) form the backbone of Kenya's economy, contributing significantly to employment and Gross Domestic Product (GDP).

However, access to affordable credit remains a significant hurdle for these businesses.

Uncapped interest rates discourage borrowing, as high repayment costs make it infeasible for SMEs to expand or even sustain operations.

Reintroducing interest rate caps would lower the cost of borrowing, encouraging more SMEs to access credit.

This, in turn, would stimulate economic activity, create jobs, and increase government revenue through taxes.

Furthermore, a cap would help align the interests of banks with national economic goals, ensuring that lending practices contribute to broader development objectives rather than short-term profit maximization.

Reducing income inequality. Kenya grapples with significant income inequality, with a large portion of the population living below the poverty line.

High interest rates exacerbate this issue by limiting financial access for the poor while favouring wealthier individuals and larger corporations that can negotiate better terms.

Without caps, the financial system risks perpetuating a cycle of inequality, where only the affluent benefit from affordable credit.

Interest rate caps can help bridge this gap by ensuring uniformity and fairness in lending practices.

By making loans more accessible to all segments of society, caps promote inclusive growth, empowering low-income earners to invest in education, health, and business opportunities.

Mitigating systemic risks. Excessively high interest rates pose systemic risks to the economy. When borrowers struggle to meet repayment obligations, default rates increase, potentially destabilising the financial sector.

This risk is particularly acute in Kenya, where informal businesses and individual borrowers constitute a significant portion of loan recipients.

Interest rate caps can mitigate these risks by reducing the likelihood of defaults.

Affordable borrowing costs enable individuals and businesses to manage debt more effectively, maintaining stability in the banking sector.

Moreover, predictable interest rates foster trust in the financial system, encouraging more people to engage with formal financial institutions.

Aligning with global best practices. Many countries, including Germany, France, and South Korea, have successfully implemented interest rate caps to protect consumers and maintain economic stability.

These caps are often part of broader regulatory frameworks designed to balance profitability and social responsibility within the banking sector.

Kenya can draw lessons from these countries, tailoring its approach to fit local contexts.

Reverting to interest rate caps would signal a commitment to protecting citizens from financial exploitation while aligning the country with global best practices.

This alignment could also enhance investor confidence, as a stable and equitable financial environment is attractive to both domestic and international stakeholders.

Promoting financial discipline among banks. Without interest rate caps, banks are incentivized to prioritise short-term profits over long-term sustainability.

High-interest loans generate substantial revenue in the short run but can lead to increased defaults and reputational damage over time.

By capping rates, the CBK would encourage banks to adopt more sustainable lending practices, focusing on innovation, efficiency, and customer service to remain competitive.

Furthermore, caps would push banks to explore alternative revenue streams, such as digital banking solutions and value-added services, rather than relying solely on interest income.

This shift could enhance the overall competitiveness and resilience of Kenya's banking sector.

Addressing the Challenges of the Previous Cap. Critics of the earlier interest rate cap argue that it led to reduced credit access, particularly for high-risk borrowers, as banks shifted their focus to lending to government and large corporations.

While this concern is valid, it highlights the need for a more nuanced approach rather than a complete abandonment of the policy.

The Central Bank of Kenya (CBK) could reintroduce caps with adjustments to address these shortcomings.

For instance, the cap could be set at a higher threshold to provide banks with sufficient margins for risk assessment. Additionally, the CBK could implement complementary measures, such as credit guarantee schemes, to encourage lending to SMEs and low-income earners.

In a nutshell, the argument against caps often centers on the need for market-driven solutions. However, in a context where market forces have historically favoured the powerful at the expense of the vulnerable, regulation becomes indispensable.

By reinstating caps, the CBK would not only safeguard the interests of Kenyan borrowers but also contribute to the country's long-term economic prosperity.

Mr. Abol Kings is a personal finance coach, a teacher and a former banker.