In the latest treasury bond issue, investors asked for over 18% interest rate, forcing the government to reject most bids. The rising interest rates have reignited the clamor to control interest rates. Baringo North MP Joseph Makilap has drafted a Bill to reintroduce the controls which were abolished in 2019 after disastrous economic consequences.
This steep rise in interest rates cannot be sustained. It might become necessary to regulate the rates to avoid overheating the credit markets. High-interest rates will increase business costs, leading to further economic slowdown.
The previous attempt at controlling interest rates failed mainly due to the flawed nature of the law. The law prescribed a single rate without any reference to the borrower’s risk. Banks were forced to stop lending to borrowers whose risk profiles placed them beyond the legally mandated rate.
If we are to succeed in regulating interest rates, the new law should set multiple rate corridors to accommodate all borrowers. I argued for this many times during the previous clamor to control interest rates. The borrowers can be classified as low, medium, and high.
Each of the categories should have a rate calculated as CBR+Risk Premium. The Risk Premium for each category should be fixed in law, or CBK can be empowered to set it monthly.
The controls should ensure that no borrower, regardless of risk profile, is charged more than 20% interest rate on any facility. A legal mechanism should be to stop banks from engaging in predatory lending. If a borrower can only access a loan at over 20% interest rate, then lending to such a person is predatory since default is almost inevitable.
The country can develop other mechanisms to finance risky but viable business ideas. Banks and Fintechs shouldn’t be left to lend money at any price.
I hope we get it right this time around. Price controls are a regulatory tool to force positive market behavior when market forces have failed or threatened the economy. This issue can be solved amicably if politicking is taken out of the debate.
Author: Ephraim Njega – FinTak.