OREANDA-NEWS. Kenya's leading banks are better placed than their smaller competitors to manage the fall in profitability and rise in loan impairments likely to arise from proposed new rate caps, Fitch Ratings says.

The Banking (Amendment) Bill proposes to regulate both loan and deposit rates. The proposals, passed by Kenya's parliament 27 July, include a loan rate cap of 4% above the central bank's benchmark rate (CBR), currently 10.5%, and a floor on deposit rates of 70% of the CBR. The bill is still subject to presidential sign off.

The immediate impact will be a sharp reduction in net interest margins for all banks. But large players, with stronger franchises and more diverse business models, should be able to attract new business and, with greater volumes, offset some of the squeeze on profitability.

We think loan rate caps will also make it difficult for banks to price risk correctly, leading to further weakening of asset quality. Banks might also become more reluctant to lend, adding further pressure on economic growth. . South Africa recently introduced a rate cap on unsecured consumer lending, which has led to a retrenchment from this segment by some banks.

If rates are capped, Kenyan banks are more likely to become risk averse and place excess liquidity into government bonds. Profitability could be squeezed as a result, although banks could try to offset this by increasing fees and cutting costs. If some types of lending prove to be unprofitable, business models might have to be overhauled, particularly at the smaller banks.

Interest rates in Kenya have been stubbornly high and a key contributor to the build-up of non-performing loans (NPL) in recent quarters. NPLs reached 8.4% of gross loans at end-June 2016, up from 5.7% at June 2015, according to the central bank. Other factors also contribute to recent asset quality deterioration, such as weaker credit growth, which means NPLs are measured against a shrinking volume of outstanding loans. Sector-specific issues also play a part, such as pressure in the agriculture, real estate and tourism sectors. Kenya's 'B+' sovereign rating is on Negative Outlook.

Kenyan banks have priced loans off the Kenyan Banks' Reference Rate (KBRR) since 2014, which currently stands at 8.9% with the average lending rate standing at 18.2%. If the rate cap is introduced and assuming no change in the CBR, this would mean that no loan could be priced above 14.5%, almost 400bp below the current average lending rate.

Rate caps could also force loan prices to converge, forcing lenders to compete more aggressively on products and service. This is more likely to benefit larger banks.