Taming Predatory Lending for a Resilient Financial System and Economic Growth

Abstract

Kenya’s credit market has gone a full circle in just about three years. Before2016, interest rates were to a large extend liberalized, and relatively high to the frustration of policymakers. High interest rates are an obstacle to domestic investments while at the same time they contribute to bank profitability. The fact that banks were very profitable in the context of household and individual in-debtness with low returns on savings was perceived as unethical and un acceptable. A group of lawmakers moved a motion that was unanimously passed in parliament in 2016 to introduce interest rate controls2. The objective of the interest rate controls was to reduce the cost of credit, increase or expand access to credit while increasing the returns on savings. However, there is evidence that "the law on interest rate controls obtained the opposite effect. Specifically, it led to a collapse of credit to micro, small, and medium enterprises, as well as individual credit; shrinking of the loan book of the small banks; and reduced financial intermediation” (Alper et al. 2019 p.1).Three years down the line in 2019 the law that provided for interest rate controls was repealed The real problem with interest rate controls was the inability for banks to price for risk. As such, government bonds became more attractive to financial institutions as opposed to lending to micro and small enterprises which were perceived as risky despite their crucial role in employment creation, investments and economic growth. The interest rate controls, therefore, created a vacuum where the so-called risky borrowers (firms and individuals alike) had to look for other avenues to access to credit. This policy brief is critical especially in the wake of the 2019 financial access survey that showed that the percentage of people with access to credit services was at 82.9 per cent, up from 26.7per cent in 2006 and 75.3 per cent in 2016.The same survey found that financial health(the ability to cope with unexpected financial demands) was worsening. Much of the access to credit is fuelled by aproliferation of lenders using mobile phone technology to give quick small loans with terms that are otherwise unfair to the wellbeing of the borrower. This amounts top predatory lending, a lending practice with unfair or abusive loan terms on a borrower. It also amounts to a coercive practice that convinces a borrower to take a loan that they can do without