Will capped interest rates benefit Africa's economies?
When banks can no longer charge high rates to offset their risks because of an interest rate cap, they shun riskier borrowers.
When Kenyan President, Uhuru Kenyatta, signed a law that capped bank lending rates on August 24th, he justified his decision by stating that Kenyans have long been frustrated by the high cost of credit that was prevalent in East Africa's largest economy. His position was that banks ought to do more to ensure that their customers benefit from the financial sector by reducing the cost of credit.
The new law, which came into force on September 14th, capped bank lending rates at 4 percent above the central bank's benchmark rate – which is currently at 10 percent. The same law also capped deposit rates at 70 percent of the central bank's rate.
Critics – including the Central Bank of Kenya, bankers, and the International Monetary Fund – have warned that the law would reduce the flow of credit to key sectors of the economy, as well as threaten the country's reputation as a regional freemarket financial centre. But Kenyans have largely welcomed the new law. Kenya's leading newspaper, The Daily Nation, declared: “Why low bank rates are good for your family”; The Star, another major newspaper, also declared: “Law to cap interest rates welcome.”
Given the situation in the country's credit market, it is not hard to understand why Kenyans have embraced the new law. In Kenya, over 60 percent of the country's adult population lack access to formal credit, while about 40 percent of the population patronize informal financial groups such as rotating savings credit associations (ROSCA). Furthermore, most Kenyan small businesses – which account for 75 percent of the general employment and contribute 18 percent to the country's GDP – struggle to access bank loans at interest rates of over 18 percent.
The Kenyan situation helps to illustrate why interest rate caps remain a populist monetary policy tool for consumer protection against high interest rates. According to a 2014 World Bank report, at least 76 countries around the world still use some form of interest rate caps on loans. These countries range from developed economies – such as United States, Germany, United Kingdom and Japan – to less developed economies, such as China, India, Brazil, and Turkey.
In Sub-Saharan Africa (SSA), interest rate caps exist in 24 countries including Nigeria, South Africa, Ghana, Zambia, and Namibia. Interest rate caps in Nigeria doesn't exist as a blanket ceiling on loans and deposits as is the case in Kenya. However, the Central Bank of Nigeria (CBN) periodically publishes “guidelines” for banks relating to commissions, fees, and rates for various products and services such as loans, deposits, electronic banking, overdrafts, commissions on turnover, current account maintenance fees, mortgage loans, foreign exchange charges, etc.
These regulatory rules ensure that bank services in Nigeria, particularly credit facilities, are offered to customers at rates engineered by the CBN. Beyond this, the CBN also has a number of intervention funds, which are disbursed by some governmentsponsored development finance institutions, as well as commercial banks. These funds are usually mandated to lend at single-digit interest rates. A recent example is the N500 billion Export Stimulation Facility, which is being managed by Nigerian Export-Import Bank.
In South Africa, the interest rate cap came by way of the 2005 National Credit Act, which went into effect in 2007. The Act introduced a cap of 5 percent per month on short-term loans and re-imposed a cap on small loans, which was earlier abolished in 1993. Furthermore, the Act recognized seven credit subsectors with different maximum interest rates linked to a benchmark rate set by the Reserve Bank of South Africa.
Countries under the West African Economic and Monetary Union (WAEMU) have a maximum interest rate of 15 percent for commercial banks and 24 percent for microfinance institutions. All this goes to show that interest rate cap is extensively used in SSA countries.
The main reason for the prevalence of interest rate caps, particularly in Africa, is that governments want to keep interest rates low in order to improve access to credit. This is a noble intention. Several studies have found that expanding credit to urban or rural households raise their economic welfare, as they are able to engage in small and medium enterprises and also save. A survey by the International Development Association and the Bangladesh-based Palli Karma Sahayak Foundation found that micro-credit programmes improved borrowers' income by 98 percent; quantity and quality of food intake by 89 percent; clothing by 88 percent; housing condition by 75 percent; children's education by 75 percent; sanitation condition by 69 percent; and overall quality of life by 95 percent.
Nevertheless, some other studies have established that interest rate caps make it harder – not easier – for poorer consumers to access credit. This is because banks reserve the most expensive credit for high risk borrowers, such as poor people without credit histories or SMEs without highquality collateral. When banks can no longer charge high rates to offset their risks because of an interest rate cap, they shun