On 14th March 2019, the court delivered a momentous 121-page Judgement that has an impact on financial institutions and borrowers alike. The media put out alarmist headlines that set the public in a panic over the fate of their loans.
In this article, we seek to offer a brief insight into the reasons behind the court’s ruling and the consequences of the Judgement.
Was the capping of the interest rate by the National Assembly (Parliament) unlawful?
No! The court held that Parliament is tasked to pass laws, and it acted within its constitutional mandate in enacting the law capping the interest rate charged by Banks.
Why was the Section on the capping of interest rate declared unconstitutional?
The court held that while Parliament acted within its mandate in passing the law, it was the failure by Parliament to define the technical words used in the Section that makes the section unconstitutional.
Below are the technical terms that the court deemed as ambiguous in the law capping the interest rate;
AMBIGUITY ON THE WORD CREDIT FACILITY
In 2016, the law introduced an interest rate ceiling to the effect that;
“A Bank…shall set the maximum interest rate chargeable for a credit facility…at no more than 4%, the Central Bank Rate set and published by the CBK….”
The court held that this provision is ambiguous for the following reasons;
The law states that the capping of interest rate is applicable to credit facilities, which, when strictly defined, means a type of corporate loan where the loan amount is not disbursed all at once and interest is only charged on the amount disbursed;
Therefore, the capping of interest rate only applies to credit facilities, and not all types of loans id strictly interpreted;
However, some have argued that the intention of Parliament was that capping of interest rate was meant to affect all loans;
This leads to conflicting interpretation and there is a need for Parliament to provide clarity on whether capping of interest rate was applicable to all loans or just to credit facilities.
AMBIGUITY ON THE BASE RATE
The court held that while the law provides that Banks should not charge interest rate “at no more than 4%, the Central Bank Rate”, it was unclear whether
The Central Bank Rate referred to the rate as defined in the Central Bank Act or to any discretionary rate the Central Bank sets as the Base rate;
The omission of the word “of” in the phrase.e.–“at no more than 4%(*), the Central Bank Rate” leads to lack of clarity on whether the 4% is meant to be above or below the Base Rate;
Further, the Section does not specify whether the ceiling is chargeable monthly, daily, or annually, an ambiguity quickly remedied by the CBK when it clarified that it was applicable annually.
The court held that the ambiguity on the issues relating to the Base Rate can lead to mischievous interpretations and Parliament needed to provide clarity.
SHOULD CONTRAVENING AN AMBIGUOUS LAW BE PUNISHABLE?
The law provides that any Bank that contravenes the law on the capping of interest rate will be liable to a fine of Kshs. 1 Million, and in default, the CEO will be liable to imprisonment for a term of not less than one year. The Court observed that the ambiguity of the terms “Credit Facility” and “Base Rate” may result in inadvertent contravention of the law purely on the grounds of differing interpretations.
The court, therefore, held no person should be punished if the law is unclear on what is to be complied with.
THE PENALTY ON DISOBEDIENCE OF THE CAPPING OF INTEREST RATE IS DISCRIMINATORY.
The law provides that a person shall not enter into a lending agreement where the interest rate in excess of the capping. This means that both the Borrower and the Bank have an equal obligation to comply with the law. Despite this equal obligation, the law only metes out punishment against Banks and CEOs and not against the Borrower. The court held this provision was discriminatory and, therefore, unconstitutional.
The court held that while it found the law capping interest rate unconstitutional, the effect of declaring it unconstitutional without conditions would throw the entire banking industry into turmoil.
The upshot of the Judgement is that;
That the law capping interest rate is declared unconstitutional for being ambiguous and vague;
This declaration, however, does not invalidate the Loan Agreements entered into while the law on the capping of the interest rate was operational;
To avoid confusion in the Banking industry and the ramifications on existing contracts between banks and borrowers, the effective date of the unconstitutionality of the law on capping of interest rate is suspended for 12 months from 14th March 2019 to allow Parliament to amend the law and give it clarity.
This means while the court has found the ceiling on the interest rate to be unlawful, IT DOES NOT MEAN THAT BANKS CAN CHARGE INTEREST AT THEIR DISCRETION. BANKS ARE STILL BOUND TO COMPLY WITH THE CAPPING OF THE INTEREST RATE AT 4%, THE CENTRAL BANK BASE RATE FOR THE NEXT 12 MONTHS, PENDING REGULARISATION BY PARLIAMENT.
However, should Parliament fail to amend the law after 12 months then the law on the capping of the interest rate will be invalid effectively after 12 months.
On punishment for failure to comply with the capping of interest rate, that Section is completely done away with and replaced with Section 49 of the Banking Act which provides for penalties on offenses under the Banking Act.
This means that in the intervening period, being the 12 months, should there be contravention on the capping of interest rate, the Bank will be liable to a fine not exceeding Kshs. 100,000.00 and an officer of the Bank liable to a fine not exceeding Kshs. 50,000.00 or imprisonment for a term not exceeding one year.
Note; The information provided on this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials are intended for general informational purposes only.