The Central Bank of Kenya (CBK) and commercial banks are in talks to overhaul the Banking Act to resolve a loan pricing impasse over who between the sector regulator and the Treasury has authority to approve an increase in lending rates.
The Kenya Bankers Association (KBA), the banking sector lobby, says its members are engaging the CBK on the possibility of reviewing the Banking Act to provide that the apex bank is the entity solely tasked with approving variations to loan pricing by commercial banks.
KBA is currently in the Supreme Court looking to squash Section 44 of the Banking Act which requires financial institutions to obtain approvals from the Treasury Cabinet Secretary before altering loan rates.
Section 44 of the Banking Act states that “No institution shall increase its rate of banking or other charges except with the prior approval of the Cabinet Secretary.”
In practice, banks have been raising or lowering their lending rates under the supervision of the CBK. Scores of borrowers have over the years obtained court judgments faulting banks for not obtaining prior approval of the Treasury Cabinet Secretary before changing loan rates, causing uncertainty and protracted litigation.
In some cases, courts have ruled in favour of banks, saying they are not required to seek the minister’s nod, highlighting the challenges presented by the controversial section and its interpretation.
The CBK and banks reckon overhauling the Act will be the silver bullet to the court disputes over loan pricing adjustments.
“The CBK governor has indicated that we have got to a point where we need to comprehensively review the Banking Act,” said KBA chief executive officer Raimond Molenje.
“What we need to do is to embed the current risk-based credit pricing framework into the Banking Act to remove the requirement of getting approvals from the National Treasury Cabinet Secretary. That would cure the politics over who gets to approve changes in bank rates between the Treasury and CBK.”
The dispute over who approves loan price changes by commercial banks goes back decades to a May 2006 legal notice by the then Finance minister Amos Kimunya, who delegated the powers over interest rate variation to the CBK Governor “for the time being.”
The Treasury has taken a backseat on the setting of interest rates ever since, with banks routinely seeking clearance from the CBK.
Lawsuits brought by borrowers against their banks over loan pricing variation have, however, haunted the industry, prompting an evaluation of the current law by the courts.
Santowels, a sanitary towel manufacturer, was the first to test the interpretation of Section 44 of the Banking Act, falling out with Stanbic Bank Kenya over what it said was the varying of interest rates to levels it felt were unjustified. The firm moved to court in 2003, arguing that the bank unilaterally varied interest rates without seeking the Treasury’s approval, and charged it Sh17.25 million in extra interest for several loans contracted between 1993 and 1997.
The suit escalated from the High Court to the Court of Appeal, and finally the Supreme Court, which determined in June last year that interest rates on loan facilities advanced by banks are subject to regulation under Section 44 of the Banking Act, requiring prior approval from the Treasury Cabinet Secretary.
Spire Bank was previously found to have breached the law after varying interest rates on a customer loan without Treasury’s approval after which it was compelled to reduce an outstanding loan balance.
The court decisions sent shockwaves in the banking industry, sparking fears of an avalanche of suits against more lenders over loan pricing variations. KBA, which was previously barred from joining the court battles against its members –Stanbic and Spire Bank, subsequently moved to the High Court seeking orders to declare Section 44 of the Banking Act unconstitutional.
The lobby argued that the section violated constitutional provisions safeguarding the CBK’s independence in monetary policy formulation.
KBA argued that interest-rate adjustments are a key instrument of monetary policy and that requiring the approval of the Treasury Cabinet Secretary, even when the CBK directs such adjustments, would give the minister supervisory or veto powers over the central bank’s monetary operations.
The High Court rejected KBA’s petition arguing that there existed a clear distinction between the CBK’s monetary policy function and commercial lending practices, which were deemed to be the subject of parliamentary regulation.
In August this year, banks got a temporary relief as the clause was suspended pending the determination of KBA’s challenge of the High Court’s decision at the Court of Appeal.
In its move to court, KBA said it was not asking for the re-interpretation of Section 44, but to determine whether the provision, as interpreted by the Supreme Court, is consistent with Article 231 of the Constitution which guarantees the independence of the CBK as a key national institution.
The CBK has largely stayed on the sidelines as commercial banks battle borrowers in court over the interpretation of Section 44 of the Banking Act.
The apex bank, however, differed with the Supreme Court judgment, saying it expected banks to vary loan rates immediately it revises the benchmark Central Bank Rate (CBR).
CBK Governor Kamau Thugge recently told bankers that monetary policy decisions are independent and should be implemented directly by banks without going through the Treasury.
The CBK has over the past two years been pushing banks to pass on lower borrowing costs to customers after cutting its benchmark rate.
The CBR is tied to the total cost of credit, forming one of two industry adopted benchmarks for loans.
The second –the Kenya Shilling Overnight Interbank Average (Kesonia)— is also tied to the CBR by virtue of a narrow interest rate corridor established around the benchmark rate.
Reforms being considered in the overhaul of the Banking Act include the creation of a sector tribunal to serve as a first port of call for customer disputes.
“This would provide a forum for customers to have conversations with banks. It would reduce situations where any small frictions have landed in courts which take too long to decide. A tribunal would be able to resolve a matter between three and six months once legislated,” Mr Molenje added.
