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Non-compliance with these limits is, well, against the law. Not only do most credit institutes calculate interest charges on loans, they also calculate charges. Likewise, they not only prepay interest on savings, but also partly levy disbursement charges. The six biggest Kenyan banking groups, which together own 87% of the bank custody and 76% of the credit account, levy charges on at least one of their credit product in excess of the specified interest on it.
Sometimes these charges are as high as 2.5% of the entire amount of the credit. Similarly, all of them calculate payout charges on at least one of their saving deposits with charges up to Sh120 per deal. Under the new legislation, there will be transparency for customers as to what they will pay over and above a basic level, which is a laudable move towards protecting them.
Indeed, the CBC has been at the forefront from the outset by establishing the Kenya Bank Reference Council (KBRRR) and posting loan interest across all major financial institutions on its website. KBRRR is the mean of the minimum interest level calculated by KBK for loans to commercial customers and the 91-day Treasury Bill interest level, which can be regarded as the equivalence of the risk-free level in the business world.
This allows the consumer a low-risk bench marks when benchmarking the prices of credit commodities. More enthusiastically debated and followed are the interest cap proposals. Zinscaps are widespread worldwide, with half of the sub-Saharan African states using this instrument.
Majorities of jurisdictions use cap lending to limit excessive and inappropriate interest on loans (often termed usury). Therefore, interest cap interest could be seen as a political intervening to reduce the costs of credit to the consumer. But what are the effects of using such an interference?
Currently, the current interest in Kenya is 18%. Treasuries have a 91-day treasury bill treasury of 8.6%. Since treasury notes are the lowest-risk commodity of the private sector, the differential between these and the interest on loans of the bank is the cost of risk-taking loans. Those installments high? But are these interest levels urgently in need of political action?
What is important to ask is what kind of issue the interest ceiling is trying to resolve. However, it is doubtful that interest cap interest subsidies as a political instrument will properly tackle some of the major Kenyan markets failure, in particular bad lending disincentives. How does an interest ceiling of four percent above a basic interest level set by the CBC affect it?
It is a hypothetical situation that nothing will be changed, either in the actual price of loans or in deposit income. Institutions can react by switching their rates to rates to compensate for the differences. In the longer run, this will be detrimental to the consumer as they may have difficulties in collecting and interpreting these levies, i.e. it would run contrary to the other great objective of the Banking Act, namely to increase openness.
However, as long as a bank only recovers the differential in these charges and keeps actual rates the same, the lending and deposits market will not be affected. It is interesting to note that this could be seen as the best one. What if the shortfall is not completely filled by banking through a new charging system?
Incentives to extend loans will continue to decrease and border on a squeeze on loans that hit high-risk clients or are more expensive to obtain. Such clients may be disproportionate in the lower -income sections of the populace or in small and medium-sized enterprises (SMEs), where loans potentially generate the highest returns for the community economies.
Moreover, this squeeze on loans is exacerbated as a result of less incentive for bankers to take deposit - bear in mind that 72 per cent of bank debt comes from deposit. Are you wondering why bankers don't just stick to the directive and adapt interest levels? 9% (current KBBR-rate + 4%) who run the risk to lose the cash or loan it to the goverment by purchasing treasury notes with an almost guarantee yield of 9%, what would you do?
Ideally, the worse case scenario could be a squeeze on loans, further disempowering those who profit most from them and who should be given incentives to do so. It is not clear, for example, what the basic interest set by the Act relates to. Today we have the CBR and KBBR interest sets, which currently differ by 1.6 percent.
How do you deal with a product like M-Shwari that does not collect an interest payment but a 7.5% credit line on a month's credit? Perhaps a better political choice would have been to concentrate on the creation of openness around the actual interest levels faced by today's consumer. Charges shall be shown as part of the costs of a credit or the redemption of a contribution and in a manner that is open and comprehensible.
Secondly, we should focus on how we can develop our official finance service (loans and deposits) for the less affluent persons in the business community. It is likely that Cap's will continue to limit the provision of finance to these very individuals, as can be seen in many other places, particularly sub-Saharan Africa. By 2016, it will be 3% - and we're sure it's in nobody's interest to undo this remarkable work.