Previous efforts to cut high interest rates on commercial loans in sub-Saharan Africa have had little success. Alnoor Amlani asks whether Kenya’s price cap will fare any better
This article was first published in the October 2016 international edition of Accounting and Business magazine.
Sub-Saharan Africa has some of the highest interest rates in the world, according to a study last year by Investmentfrontier.com. Three of the six countries with the world’s highest interest rates are in sub-Saharan Africa. The three are Malawi, Gambia and Ghana, and they reflect the broad picture in the region – and, indeed, the wider African continent – of generally high interest rates.
Interest rates in sub-Saharan Africa are commonly above 20% a year for borrowers, and the spread between lending and borrowing rates is also extremely high (8%-10%) compared with spreads at commercial banks in other regions of the world. Banks cite a high-risk environment and high inflation as well as financial volatility as explanations for this situation.
Efforts to cut commercial lending rates so as to encourage startup businesses and to foster growth for small and medium-sized enterprises (SMEs) have not typically been successful in the past.
But in August this year, in an effort to change that, Kenya passed an unprecedented law placing a nationwide ceiling on loan interest rates and a floor on deposit rates for all financial institutions, thereby imposing a form of price control on the banking industry. The move threatens the traditional profit base of the region’s commercial banks because, as the most developed economy in sub-Saharan Africa, Kenya sets the trend. It could mean the same controls will be imposed in other East African countries, especially as the region moves further down the road to monetary union and a common market.
Kenyan commercial banks have moved quickly to publish a common lower lending rate of 14.5% based on the central bank rate. Predictably, entrepreneurs have supported the legislation, more so since some banks have indicated they will apply the rate to loans too.
But analysts are watching closely. An ill-considered price cap in a relatively open market will often quietly turn it a black market. Some bank collapses in Kenya have highlighted the issue of undeclared deposits and parallel banking in the banking sector where depositors pay to deposit instead of being paid interest because their funds are ‘dirty’. These funds do not even have to be lent onwards. Such distortions, if they are indeed widespread, could mean that these regulations will do little to bring new businesses to the market and encourage SMEs to grow.
What’s more, the regulations do not affect government borrowing. Banks may therefore simply buy more Treasury bills and avoid lending very much to the private sector at all.
It remains to be seen if the interest rate price caps will work in practice for the formal banking sector.
The real problem may be that banks are so risk-averse because they are not strictly local institutions. Many have foreign investors or large depositors. The best alternative for many Africans needing to borrow are the savings and credit societies (Saccos) created to pool people’s savings and share borrowing opportunities between them.
Saccos are exclusively local and because of their low operational costs can charge effective rates of less than 10% a year. However, they can lend only to individual members of the Sacco, so such loans tend to be for household needs.
Alnoor Amlani FCCA is an independent consultant based in East Africa