## wpiea2019119

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---

### Executive summary and context
- September 2016 law imposed:
  - a ceiling on lending rates at "4 percent above a 'reference rate'"; and
  - a floor on time deposit rates equal to "70 percent of the 'reference rate'".
- The Central Bank Policy Rate (CBR) was set as the reference rate by CBK. At implementation the CBR was 10.5 percent, implying:
  - deposit rate floor of 7.35 percent; and
  - lending rate cap of 14.5 percent.
- At introduction, the controls affected more than half of all existing loans and deposits.
- Authors’ principal findings:
  - Controls produced effects opposite to lawmakers' intent: instead of expanding credit and increasing returns on savings, the controls contributed to a collapse of bank credit to micro, small, and medium enterprises (SMEs); shrinking of small banks’ loan books; and reduced financial intermediation.
  - Interest rate caps reduced the signaling effects of monetary policy.
- Key policy implications highlighted:
  - Adverse effects could largely be avoided if the lending ceiling were high enough to facilitate lending to higher-risk borrowers.
  - Alternative policies could be preferable to address concerns about the high cost of credit.

### Financial sector structure and pre-control trends
- Interest rate spread and profitability trends:
  - Average intermediation spread declined from 14.9 percent in 2002 to 8.3 percent in 2015.
  - Return on assets (after tax): 1.4 (2002) and 1.6 (2015).
  - Personnel costs (% of operational costs): 40.4 (2015).
- Decomposition of spread (selected items shown exactly as in source):
  - Interest earned on loans: 18.3 (2002); 15.3 (2015).
  - Interest paid on customer deposits: 3.4 (2002); 7.0 (2015).
  - Spread: 14.9 (2002); 8.3 (2015).
  - Interest paid to cover required reserves: 0.3 (2002); 0.3 (2015).
  - Loan loss provisions/loans: 2.5 (2002); 1.5 (2015).
  - Operating costs/loans: 5.9 (2002); 6.1 (2015).
  - Pre-tax profit: 6.2 (2002); 0.4 (2015).
- Market structure:
  - Herfindahl-Hirschman index < 0.1 and the lowest in Africa at time of controls, suggesting concentration was not high.

### KBA and CBK survey evidence on bank exposures and rates
- KBA survey (August 2016; 28 of 40 commercial banks; responders accounted for about 73 percent of the banking sector):
  - About 60 percent of outstanding loans were at interest rates above the lending rate ceiling. The share was roughly uniform across different bank groups by size.
  - Share of bank loans to SMEs:
    - Overall banking sector: about 18 percent.
    - Small banks: about 40 percent.
    - Large banks: 13 percent.
  - Average lending rate to SMEs was broadly uniform across bank groups.
  - Share of consumer loans was higher for large banks; rates for consumer loans were roughly uniform across bank sizes.
  - More than half of outstanding saving deposits carried an interest rate below the deposit rate floor; however, the deposit rate floor affected (on average) over half of bank deposits, but only about one third of deposits in small banks.
  - Small banks relied more heavily on interest-earning deposits and paid a higher interest rate at adoption relative to medium and large banks.
- CBK survey (one year after introduction; 32 banks representing over 80 percent of sector; data through September 2017) used to assess impact.

### International literature summary (selected findings)
- Common problems associated with lending rate ceilings:
  - Reduced financial intermediation — banks reduce loans to small, costlier-to-serve borrowers and reallocate to government and large borrowers.
  - More, not less, predatory lending — borrowers excluded from bank credit may turn to informal lenders charging much higher rates.
  - Reduced transparency — lenders may increase non-interest fees and commissions.
  - Elevated risks to financial stability — binding ceilings/floors can hurt viability of small and medium-sized banks.
- Empirical manifestations in other countries include withdrawal from poor/segment markets, increase in average loan size, proliferation of fees, reduced product diversity and competition, and increase in illegal lending.

### Measured impacts of the Kenyan interest rate controls
- Credit to SMEs and bank segmentation:
  - Stock of credit to SMEs dropped by around 10 percent in one year (index Sep. 2016 = 1, Figure 2, panel A).
  - Outstanding stock of credit of small banks declined by about 5 percent in the 12 months to September 2017 (Figure 3, panel B).
  - Credit slowdown started about a year before lending caps, but small banks were disproportionately hit due to reliance on higher-risk/higher-return borrowers (SMEs), many priced above the cap.
- Sectoral shifts and financial intermediation:
  - Overall credit to the private sector grew 2 percent y/y as of end-October 2017 (nominal), resulting in a sharp decline in real terms and as a share of GDP.
  - Lending to the public sector increased sharply, with growth of over 25 percent during the same period.
  - Developments characterized as reduced financial intermediation rather than crowding out, given that T-bill rates remained broadly unchanged after controls.
- Access to credit and borrower composition:
  - Reduction in the number of borrowers since introduction of lending caps: about 27 percent.
  - Average loan size increased by about 47 percent.
  - No evidence that high-risk borrowers excluded by banks moved to other regulated lenders not subject to caps (e.g., micro-finance institutions and SACCOs), as growth of lending by these institutions remained broadly unchanged through end-September 2017.
- Sectoral credit effects (index Sep. 2016 = 100, selected sectors):
  - Trade sector (accounts for ~20 percent of total private sector credit): stock of credit dropped by about 3 percent.
  - Agriculture and financial services (combined ~7 percent of outstanding bank credit) experienced declines.
  - Construction sector continued to grow rapidly.
- Regression evidence (Table 4: Short-term Trend Reversal Following Interest Rate Controls; quarterly, Dec. 2014 – Sep. 2017). Example coefficients reported exactly as in source (pre-controls / post-controls / difference):
  - Credit to MSMEs relative to corporate sector: 0.23** / -0.59** / -0.82**.
  - Small banks' credit relative to large banks' credit: 0.02** / -0.23** / -0.25**.
  - Public sector credit relative to deposits: 0.11* / 0.22** / 0.12**.
  - Private sector credit relative to deposits: 0.37** / 0.28** / -0.09**.
  - Private sector real credit growth: 0.06** / 0.00 / -0.07**.
  - Notes:
    - Implementation starts from 2016Q4.
    - Estimation for 2003Q1-2018Q1 for some series.
    - * Denotes significance at 5% level based on Newey-West standard errors.
    - ** Denotes significance at 1% level based on Newey-West standard errors.

### Analysis and interpretation
- Mechanisms driving adverse outcomes:
  - Lending-rate caps compressed spreads in ways that made lending to higher-cost/higher-risk borrowers (SMEs) unprofitable or unattractive, leading to withdrawal of credit to those segments.
  - Small banks' business models—relying on higher-cost funding to lend to SMEs—made them particularly vulnerable when rates were capped.
  - With lending to private sector constrained, banks shifted lending toward the public sector where rates and risk profiles were more compatible with the new constraints.
  - Interest-rate caps weakened the policy-rate signaling channel, complicating monetary policy communication.
- Observed trade-offs:
  - Controls aimed to lower borrowing costs and increase savings returns, but net effects included reduced access to bank credit for SMEs and poorer transparency (e.g., potential for higher non-interest fees).

### 2017: trends, channels, and macro impact estimates
- Trends in credit and deposits:
  - Starting in mid-2014, growth of both deposits and lending by banks began to slow.
  - Deposits rebounded since early 2017, while credit to the nominal private sector remained broadly unchanged, growing at about 2 percent y/y over the past several months.
  - Past correlation between deposits and lending growth rates was about 0.9; breakdown since the interest rate controls is used to infer part of the controls' impact on growth.
- Shift in deposit composition and loan maturity:
  - Floor on the interest rate for time deposits led to a sharp decline in time deposits and an increase in demand deposits that are not remunerated.
  - The ratio of time deposits to demand deposits declined by 30 percentage points (from 130 percent at the end of July 2016 to less than 100 percent in October 2016).
  - The average maturity of new loans has declined due to the lending caps.
- Bank profitability and behavioral adjustments:
  - Lending income shifted toward fees and lending to the government, and away from interest income on private sector lending.
  - With lending rates capped at 13-14 percent, long-term government securities yield similar returns and present additional advantages (higher creditworthiness, no borrower screening, no loan servicing administrative costs, no additional capital for nonperforming loans, ability to sell securities).
  - Return on equity (RoE) for banks declined in 2017 relative to 2016; small banks were disproportionately affected and had profits already below the industry average.
  - Banks cut staff (by around 6 percent in 2016) and increased reliance on digital channels to reduce costs and overhead.
- Intermediation spread decomposition — key statistics (2015 vs 2017, annual basis; simple averages across banks):
  - Average commercial bank intermediation spreads declined from 830 basis points in 2015 to 660 basis points in 2017.
  - Selected decomposition items (Total):
    - Interest earned on loans: 15.3 (2015) → 11.8 (2017)
    - Interest paid on customer deposits: 7.0 (2015) → 5.2 (2017)
    - Spread: 8.3 (2015) → 6.6 (2017)
    - Interest paid to cover required reserves: 0.3 (2015) → 0.2 (2017)
    - Loan loss provisions/loans: 1.5 (2015) → 2.0 (2017)
    - Operating costs/loans: 6.1 (2015) → 6.1 (2017)
    - Pre-tax profit (attributable to intermediation of loans): 0.4 (2015) → -1.8 (2017)
    - Return on assets (after tax): 1.6 (2015) → 0.5 (2017)
    - Personnel costs (% of operational costs): 40.4 (2015) → 38.8 (2017)
  - Declines in average effective lending rates were accompanied by declines in average deposit rates due to the shift from time to demand deposits.
  - Average operating costs remained broadly stable, while average profit margins on private sector lending activities declined further and turned negative.
- Reduced monetary policy effectiveness and liquidity outcomes:
  - Prior to controls, CBK adjusted the CBR in response to inflation and growth; after the caps, CBK kept the policy rate unchanged at 10 percent (until March 2018) despite lower growth and reduced core inflation in 2017.
  - Interbank interest rate averaged about 6 percent (or 400 basis points lower than the policy rate) since the introduction of the law, weakening the signaling role of the policy rate.
  - Excess liquidity kept 91-day treasury bill rates between 150–250 basis points below the policy rate since September 2016.
  - Interbank rate was highly volatile, ranging between 2.5 and 11 percent.
  - Divergence and volatility of interbank rates undermined the policy rate’s signaling role; realigning the interbank and policy rates could have prematurely tightened monetary policy.
- Gauging the impact on growth:
  - Literature benchmark: a 1 percentage point increase in private credit growth raises GDP growth by between about 0.03 and 0.075 percentage points across credit types in emerging markets.
  - Kenya estimates (quarterly data 2000Q1–2018Q1, three specifications): a 10 percentage points rise in private credit growth corresponds to higher output growth of between 0.7 and 1.5 percentage points.
  - Block exogeneity Wald tests indicate unidirectional Granger causality from private credit growth to real GDP growth in Kenya.
  - Estimated response of real GDP growth to a 1 percentage point change in real private credit growth lies between 0.07 and 0.15.
  - With nominal quarterly private credit growth at about 3.7 percent y/y as of end-June 2018 (compared to an average of about 20 percent between March 2008-June 2016), annual economic growth would, based on the above elasticities, be lower by ¾–2¼ percentage points.
  - Assuming the divergence between deposit and credit growth is due to interest rate controls, their impact on growth is assessed at between ¼ and ¾ percentage points.
  - CBK (2018) estimate: rationing out MSMEs from the credit market lowered growth in 2017 by 0.4 percentage points.
  - SME-specific channel:
    - Credit to SMEs accounted for about 17 percent of overall bank credit to the private sector in Kenya.
    - Credit to SMEs declined by about 10 percent in the 12 months since the introduction of interest rate controls, compared to growth of about 5 percent y/y before the controls.
    - Using the elasticities above, “normal” credit growth to SMEs would have implied a higher GDP growth of about ¼–½ percentage points on an annual basis.

### Concluding remarks and policy recommendations
- Controls introduced in September 2016 were among the most drastic: a floor on interest rate for all time deposits (removed effective September 2018) and a stringent cap on lending rates; about 60 percent of loans were above the cap at the time of the law.
- Since the introduction of the controls there has been:
  - (i) a sharp decline in bank credit to SMEs, especially in trade and agriculture;
  - (ii) a disproportional hit on lending activity and the profitability of small banks;
  - (iii) reduced financial intermediation, with commercial bank credit shifting away from the private sector towards the public sector.
- The paper estimates an adverse impact on GDP growth of between ¼ and ¾ percentage points on an annual basis attributable to the interest rate controls.
- Policy options to reduce adverse effects:
  - Put the lending ceiling at a rate high enough to facilitate lending to higher-risk borrowers (e.g., set the ceiling at the average of past monthly rates plus a margin). The margin would need to be substantial (in the double digits) to avoid rationing out high-risk borrowers.
  - Consider other policy instruments to increase financial access and address equity concerns, such as more progressive taxation of personal income and excess corporate profits, to avoid distortions from interest rate controls while dampening inequality.

*Source: IMF staff analysis in wpiea2019119 (2017).*

### 2016. The intent of the controls was to reduce the cost of borrowing, expand access to credit,

### wpiea2019119 - 2016. The intent of the controls was to reduce the cost of borrowing, expand access to credit,

### Executive summary and context
- September 2016 law imposed:
  - a ceiling on lending rates at "4 percent above a 'reference rate'"; and
  - a floor on time deposit rates equal to "70 percent of the 'reference rate'".
- The Central Bank Policy Rate (CBR) was set as the reference rate by CBK. At implementation the CBR was 10.5 percent, implying:
  - deposit rate floor of 7.35 percent; and
  - lending rate cap of 14.5 percent.
- At introduction, the controls affected more than half of all existing loans and deposits.
- The authors find the law produced effects opposite to lawmakers' intent: instead of expanding credit and increasing returns on savings, the controls contributed to a collapse of bank credit to micro, small, and medium enterprises (SMEs); shrinking of small banks’ loan books; and reduced financial intermediation. The authors also find that interest rate caps reduced the signaling effects of monetary policy.
- Key policy implications highlighted:
  - The adverse effects could largely be avoided if the lending ceiling were high enough to facilitate lending to higher-risk borrowers.
  - Alternative policies could be preferable to address concerns about the high cost of credit.

### Financial sector structure and pre-control trends
- Interest rate spread and profitability trends:
  - Average intermediation spread declined from 14.9 percent in 2002 to 8.3 percent in 2015.
  - Return on assets (after tax): 1.4 (2002) and 1.6 (2015).
  - Personnel costs (% of operational costs): 40.4 (2015).
- Decomposition of spread (selected items shown exactly as in source):
  - Interest earned on loans: 18.3 (2002); 15.3 (2015).
  - Interest paid on customer deposits: 3.4 (2002); 7.0 (2015).
  - Spread: 14.9 (2002); 8.3 (2015).
  - Interest paid to cover required reserves: 0.3 (2002); 0.3 (2015).
  - Loan loss provisions/loans: 2.5 (2002); 1.5 (2015).
  - Operating costs/loans: 5.9 (2002); 6.1 (2015).
  - Pre-tax profit: 6.2 (2002); 0.4 (2015).
- Market structure:
  - Herfindahl-Hirschman index < 0.1 and the lowest in Africa at time of controls, suggesting concentration was not high.

### KBA and CBK survey evidence on bank exposures and rates
- KBA survey (August 2016; 28 of 40 commercial banks; responders accounted for about 73 percent of the banking sector):
  - About 60 percent of outstanding loans were at interest rates above the lending rate ceiling. The share was roughly uniform across different bank groups by size.
  - Share of bank loans to SMEs:
    - Overall banking sector: about 18 percent.
    - Small banks: about 40 percent.
    - Large banks: 13 percent.
  - Average lending rate to SMEs was broadly uniform across bank groups.
  - Share of consumer loans was higher for large banks; rates for consumer loans were roughly uniform across bank sizes.
  - More than half of outstanding saving deposits carried an interest rate below the deposit rate floor; however, the deposit rate floor affected (on average) over half of bank deposits, but only about one third of deposits in small banks.
  - Small banks relied more heavily on interest-earning deposits and paid a higher interest rate at adoption relative to medium and large banks.
- CBK survey (one year after introduction; 32 banks representing over 80 percent of sector; data through September 2017) used to assess impact.

### International literature summary (selected findings)
- Common problems associated with lending rate ceilings:
  - Reduced financial intermediation — banks reduce loans to small, costlier-to-serve borrowers and reallocate to government and large borrowers.
  - More, not less, predatory lending — borrowers excluded from bank credit may turn to informal lenders charging much higher rates.
  - Reduced transparency — lenders may increase non-interest fees and commissions.
  - Elevated risks to financial stability — binding ceilings/floors can hurt viability of small and medium-sized banks.
- Empirical manifestations in other countries include withdrawal from poor/segment markets, increase in average loan size, proliferation of fees, reduced product diversity and competition, and increase in illegal lending.

### Measured impacts of the Kenyan interest rate controls
- Credit to SMEs and bank segmentation:
  - Stock of credit to SMEs dropped by around 10 percent in one year (index Sep. 2016 = 1, Figure 2, panel A).
  - Outstanding stock of credit of small banks declined by about 5 percent in the 12 months to September 2017 (Figure 3, panel B).
  - While credit slowdown started about a year before lending caps, small banks were disproportionately hit due to reliance on higher-risk/higher-return borrowers (SMEs), a large share of which were priced above the cap.
- Sectoral shifts and financial intermediation:
  - Overall credit to the private sector grew 2 percent y/y as of end-October 2017 (nominal), resulting in a sharp decline in real terms and as a share of GDP.
  - Lending to the public sector increased sharply, with growth of over 25 percent during the same period.
  - These developments are characterized as reduced financial intermediation rather than crowding out, given that T-bill rates remained broadly unchanged after controls.
- Access to credit and borrower composition:
  - Reduction in the number of borrowers since introduction of lending caps: about 27 percent.
  - Average loan size increased by about 47 percent.
  - No evidence that high-risk borrowers excluded by banks moved to other regulated lenders not subject to caps (e.g., micro-finance institutions and SACCOs), as growth of lending by these institutions remained broadly unchanged through end-September 2017.
- Sectoral credit effects (index Sep. 2016 = 100, selected sectors):
  - Trade sector (accounts for ~20 percent of total private sector credit): stock of credit dropped by about 3 percent.
  - Agriculture and financial services (combined ~7 percent of outstanding bank credit) experienced declines.
  - Construction sector continued to grow rapidly.
- Regression evidence (Table 4: Short-term Trend Reversal Following Interest Rate Controls; quarterly, Dec. 2014 – Sep. 2017):
  - Example coefficients reported exactly as in source (pre-controls / post-controls / difference):
    - Credit to MSMEs relative to corporate sector: 0.23** / -0.59** / -0.82**.
    - Small banks' credit relative to large banks' credit: 0.02** / -0.23** / -0.25**.
    - Public sector credit relative to deposits: 0.11* / 0.22** / 0.12**.
    - Private sector credit relative to deposits: 0.37** / 0.28** / -0.09**.
    - Private sector real credit growth: 0.06** / 0.00 / -0.07**.
  - Notes from table:
    - Implementation starts from 2016Q4.
    - Estimation for 2003Q1-2018Q1 for some series.
    - * Denotes significance at 5% level based on Newey-West standard errors.
    - ** Denotes significance at 1% level based on Newey-West standard errors.

### Analysis and interpretation
- Mechanisms driving adverse outcomes:
  - Lending-rate caps compressed spreads in ways that made lending to higher-cost/higher-risk borrowers (SMEs) unprofitable or unattractive, leading to withdrawal of credit to those segments.
  - Small banks' business models—relying on higher-cost funding to lend to SMEs—made them particularly vulnerable when rates were capped.
  - With lending to private sector constrained, banks shifted lending toward the public sector where rates and risk profiles were more compatible with the new constraints.
  - Interest-rate caps weakened the policy-rate signaling channel, complicating monetary policy communication.
- Observed trade-offs:
  - While controls aimed to lower borrowing costs and increase savings returns, the net effect included reduced access to bank credit for SMEs and poorer transparency (e.g., potential for higher non-interest fees), as documented in international experience.

### Policy implications and recommendations reported by authors
- If a ceiling is to be used, set it high enough to facilitate lending to higher-risk borrowers to avoid credit collapse for SMEs and strain on small banks.
- Consider alternative policies to address high cost of credit rather than blunt interest rate caps, given the risk of reduced financial intermediation and unintended shifts in lending toward the public sector.
- Recognize risks to financial stability from binding ceilings/floors, particularly for small and medium-sized banks whose business models depend on higher-cost funding and lending to SMEs.

*IMF Working Paper authors: EAlper@imf.org, BClements@imf.org, NHobdari@imf.org, and RMoya@imf.org*

### 2017. The number and value of mobile loans has continued to increase, but at a slower pace

### 2017. The number and value of mobile loans has continued to increase, but at a slower pace

### Trends in credit and deposits
- Starting in mid-2014, growth of both deposits and lending by banks began to slow.
- Deposits rebounded since early 2017, while credit to the nominal private sector remained broadly unchanged, growing at about 2 percent y/y over the past several months.
- Past correlation between deposits and lending growth rates was about 0.9; the breakdown in this correlation since the interest rate controls is used to infer part of the controls' impact on growth.

### Shift in deposit composition and loan maturity
- The floor on the interest rate for time deposits led to a sharp decline in time deposits and an increase in demand deposits that are not remunerated.
- The ratio of time deposits to demand deposits declined by 30 percentage points (from 130 percent at the end of July 2016 to less than 100 percent in October 2016).
- The average maturity of new loans has declined due to the lending caps.

### Bank profitability and behavioral adjustments
- Lending income has shifted toward fees and lending to the government, and away from interest income on private sector lending.
- Lending rate cap and government securities returns: with lending rates capped at 13-14 percent, long-term government securities yield similar returns and present additional advantages (higher creditworthiness, no borrower screening, no loan servicing administrative costs, no additional capital for nonperforming loans, ability to sell securities).
- Return on equity (RoE) for banks declined in 2017 relative to 2016; small banks were disproportionately affected and had profits already below the industry average.
- Banks have cut staff (by around 6 percent in 2016) and increased reliance on digital channels to reduce costs and overhead.

### Intermediation spread decomposition — key statistics (2015 vs 2017, annual basis; simple averages across banks)
- Average commercial bank intermediation spreads declined from 830 basis points in 2015 to 660 basis points in 2017.
- Selected decomposition items (Total):
  - Interest earned on loans: 15.3 (2015) → 11.8 (2017)
  - Interest paid on customer deposits: 7.0 (2015) → 5.2 (2017)
  - Spread: 8.3 (2015) → 6.6 (2017)
  - Interest paid to cover required reserves: 0.3 (2015) → 0.2 (2017)
  - Loan loss provisions/loans: 1.5 (2015) → 2.0 (2017)
  - Operating costs/loans: 6.1 (2015) → 6.1 (2017)
  - Pre-tax profit (attributable to intermediation of loans): 0.4 (2015) → -1.8 (2017)
  - Return on assets (after tax): 1.6 (2015) → 0.5 (2017)
  - Personnel costs (% of operational costs): 40.4 (2015) → 38.8 (2017)
- Declines in average effective lending rates were accompanied by declines in average deposit rates due to the shift from time to demand deposits.
- Average operating costs remained broadly stable, while average profit margins on private sector lending activities declined further and turned negative.

### Reduced monetary policy effectiveness and liquidity outcomes
- Prior to interest rate controls, the CBK adjusted the CBR in response to inflation and growth; after the caps, the CBK kept the policy rate unchanged at 10 percent (until March 2018) despite lower growth and reduced core inflation in 2017.
- The interbank interest rate averaged about 6 percent (or 400 basis points lower than the policy rate) since the introduction of the law, weakening the signaling role of the policy rate.
- Excess liquidity kept 91-day treasury bill rates between 150–250 basis points below the policy rate since September 2016.
- The interbank rate was highly volatile, ranging between 2.5 and 11 percent.
- The divergence and volatility of interbank rates undermined the policy rate’s signaling role; realigning the interbank and policy rates could have prematurely tightened monetary policy.

### Gauging the impact of the interest rate controls on growth
- Literature benchmark: a 1 percentage point increase in private credit growth raises GDP growth by between about 0.03 and 0.075 percentage points across credit types in emerging markets (Garcia-Escribano and Han, 2015).
- Kenya estimates (quarterly data 2000Q1–2018Q1, three specifications): a 10 percentage points rise in private credit growth corresponds to higher output growth of between 0.7 and 1.5 percentage points.
- Block exogeneity Wald tests in the bivariate VAR indicate unidirectional Granger causality from private credit growth to real GDP growth in Kenya.
- Estimated response of real GDP growth to a 1 percentage point change in real private credit growth lies between 0.07 and 0.15.
- With nominal quarterly private credit growth at about 3.7 percent y/y as of end-June 2018 (compared to an average of about 20 percent between March 2008-June 2016), annual economic growth would, based on the above elasticities, be lower by ¾–2¼ percentage points.
- Assuming the divergence between deposit and credit growth is due to interest rate controls, their impact on growth is assessed at between ¼ and ¾ percentage points.
- CBK (2018) estimate: rationing out MSMEs from the credit market lowered growth in 2017 by 0.4 percentage points.
- SME-specific channel:
  - Credit to SMEs accounted for about 17 percent of overall bank credit to the private sector in Kenya.
  - Credit to SMEs declined by about 10 percent in the 12 months since the introduction of interest rate controls, compared to growth of about 5 percent y/y before the controls.
  - Using the elasticities above, “normal” credit growth to SMEs would have implied a higher GDP growth of about ¼–½ percentage points on an annual basis.

### Concluding remarks and policy recommendations
- Kenya’s interest rate controls introduced in September 2016 were among the most drastic: a floor on interest rate for all time deposits (removed effective September 2018) and a stringent cap on lending rates; about 60 percent of loans were above the cap at the time of the law.
- Since the introduction of the controls there has been:
  - (i) a sharp decline in bank credit to SMEs, especially in trade and agriculture;
  - (ii) a disproportional hit on lending activity and the profitability of small banks;
  - (iii) reduced financial intermediation, with commercial bank credit shifting away from the private sector towards the public sector.
- The paper estimates an adverse impact on GDP growth of between ¼ and ¾ percentage points on an annual basis attributable to the interest rate controls.
- Policy options to reduce adverse effects:
  - Put the lending ceiling at a rate high enough to facilitate lending to higher-risk borrowers (e.g., set the ceiling at the average of past monthly rates plus a margin). The margin would need to be substantial (in the double digits) to avoid rationing out high-risk borrowers.
  - Consider other policy instruments to increase financial access and address equity concerns, such as more progressive taxation of personal income and excess corporate profits, to avoid distortions from interest rate controls while dampening inequality.

*Source: IMF staff analysis in wpiea2019119 (2017).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019119.pdf_