The dark horse in scrapping of interest rate capping

It is not obvious that banks will go to the same heights they were at before the interest capping law because in the period during which the law was effective, there was a paradigm shift to algorithm lending, in which lenders appraise their clients


I am brandishing my pen ready to play the devil’s advocate. It could have been much better if I was sipping on a cold drink, but I will tell you that even with the low interest rates, I have not found one shop that gives cool drinks on credit. 

I know it is a trivial matter, but it sets me thinking on how low interest rates should descend for there to be such a facility. In fact, the better word is how much low they should be forced to descend. I will get to this in a moment but first, let it be known to my avid readers that should I fail to do a good job in representing the devil, he does not pay so I am not under any pressure.

Peering through the dailies, there is everything but kind words for the recent move by Parliament to abolish the interest rate capping introduced in 2016. Some quarters have construed this fantastic legislation to embody a return to the dark days when banks gave punitive interest rates and made supernormal profits off their clients. Like every progressive citizen, I am also weary of that, but I also see a dark horse in this development.

Initially, the enactment of rate capping came from a good place and had noble intentions, although it was against the wishes of key sector players like the Central Bank of Kenya. At the time, theoretical speculations of what that meant could not deter the high priests of policy that were advising the President and the law saw the light of day. They say hindsight is the best sight and the writing has never been clearer. Banks have clearly demonstrated that they do not bow to the whims of political and governance bureaucrats. While at it, micro lending has had a fresh lease of life and soared to unprecedented levels never imagined before. You might be imagining that it is not so difficult for me to have my cool drink if only I can get someone to ‘Mpesa’ me, right? Well, I have an unpaid Mshwari loan. There is also fuliza which I have not sorted. Other fellows prefer KCB Mpesa and Tala just to mention a few. 

In light of the above, we may wonder which is better between the blood sucking microlending environment or the return of high interest loans through our mainstream financial system. Well, I dare say, ceteris paribus, it is not obvious that banks will go to the same heights they were at before the interest capping law. This is because in the period during which the law was effective, there was a paradigm shift to algorithm lending, in which lenders appraise their clients. Essentially, banks have impressed behavioural science in credit screening and have a wealth of knowledge regarding most borrowers. This is what should have happened in the first place to have a market driven rate decline. In developed markets whose interests we envy, transparency and information are at the heart of credit screening. 

The more exciting potential of the abolition of interest rate capping is the prospect of growing our derivatives market. Early in the year we witnessed the glamorous operationalisation of the derivatives market and are aware of the intention to grow Nairobi into a financial hub. We know from theory that derivatives are instruments designed to create certainty in environments of uncertainty. We can think of such a contract as insurance for hostile price movement. 

The rationale for taking out an insurance lies with the inability to forecast and expect risk. The moment the occurrence of a risk is known with absolute certainty, adequate measures can be taken to combat it and the logic for insurance crumbles. The same principle applies with the capping. With an interest rate capping, the incentive to participate in interest rate swaps or other interest rate related products is very low. Derivatives thrive off volatility. Fluctuations in variables causes participants to desire an insulation (insurance) against hostile price movements and this creates a demand for instruments. 

However, in an environment where interests are capped and where there is precise expectation of the wiggle room within which interest rates move, it is folly to shield oneself with an instrument or to try and speculate on the known! As such, I believe that the new development will not only lead to easier access of credit by merchants, but also portends future growth for the derivative space through the introduction of some volatility and uncertainty in
interest rates.  

The writer is a Financial economist and capital markets commentator

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