Interest rates in Kenya have had the opposite effect of what was intended. The International Monetary Fund(IMF) has published a working paper that concludes this.
Interest rate controls in Kenya got introduced in September 2016. The intent of the controls was to reduce the cost of borrowing, expand access to credit, and increase the return on savings.
The caps have reportedly led to less credit to MSMEs and reduced the effectiveness of monetary policy.
The IMF has published a working paper, which concludes that interest rate caps in Kenya have had the opposite effect of what was intended. Caps have led to less credit to MSMEs, and reduced the effectiveness of monetary policy. The full paper is at https://t.co/oEga9nSjzo
— Central Bank of Kenya (@CBKKenya) June 1, 2019
Specifically, it has led to a collapse of credit to micro, small, and medium enterprises; shrinking of the loan book of the small banks; and reduced financial inter-mediation.
The IMF working paper also hows that interest rate caps reduced the signalising effects of monetary policy. These suggest that (i) the adverse effects could largely be avoided if the ceiling was high enough to facilitate lending to higher risk borrowers; and (ii) alternative policies could be preferable to address concerns about the high cost of credit.
Mid 2016, the Kenya Government established interest rate ceilings to protect consumers largely in response to political pressure, although the CBK was against it.
Interest rate cap on loans at four percentage points above the base rate published by the Central Bank of Kenya (CBK), Kenyans were full of hope and expectations of lower interest on their loans and higher earnings on deposits.
In March 2019 the Nairobi High Court annulled the contentious banking law that caps what lenders can charge consumers for loans at 4 percentage points above the CBK, calling the legislation ‘vague, imprecise, ambiguous and indefinite’.
The general idea is that interest rate ceilings limit the tendency of some financial service providers to increase their interest yields especially in markets with a combination of no transparency, limited disclosure requirements and low levels of financial literacy.
Interest rate caps are one of those things that sound too good to be true. Why is it failing in Kenya?