8.2 Retail Finance
This section considers retail finance options in financing housing development in Kenya specifically the role of and the law around banks, mortgage finance companies, SACCOs and pension-backed lending
Kenyan banks are highly liquid and the key policy issue to consider is the ease with which banks can invest in government bonds and bills at low risk, rather than pursue investment in riskier products like housing. The figure below shows the high rate of investment from the top 8 banks into government bills and bonds. There is need to create an inducive policy environment to encourage the banking sector to lend to the housing sector – which will require collaboration amongst the banks and increased sharing of data, to reduce the risk.
The need for a stable macroeconomic environment is also illustrated by the case of Housing Finance Bank, which was able to launch a 7-year bond when the interest rate environment and exchange rate environment was stable in 2010. However, since 2010, Housing Finance Company of Kenya has struggled to replicate this access to finance due to more volatile conditions.
Construction finance is constantly raised as a gap in the housing value chain. The current metrics to obtain construction finance from banks are usually capped to approximately 60-70% of the hard construction cost, leaving the developer to fund the land cost, professional fees, and balance 30-40% of hard cost either through the developer's equity or pre-sales to buyers. The pre-sales are not protected as explained in [27. Off-plan Housing Developments under Annex F].
If one bank has provided construction finance, it is difficult for other banks to provide mortgage finance to off-takers until the land security is fully cleared. The only exception is where the individual housing units have clean title which can be charged. These fundamental collateral issues are important to enable a functioning mortgage market.
8.2.1 Banks
Commercial banks are regulated under the Banking Act 1989, Cap 488. Section 3 of the Act makes it illegal to carry on banking business without a valid licence from the Central Bank of Kenya. Provision of licenses is provided for under section 4 of the Act. Section 7 provides that a bank must maintain minimum capital requirements as set out in the Second Schedule of the Act at all times. Under the Second Schedule, there are stipulations of the core capital that must be maintained to guard against losses by consumers, preventing the collapse of banks arising from undercapitalization, and promoting depositors’/investors’ confidence. The core capital is also critical in determining how much a bank can lend to borrowers given that the Act pegs the lending ability of a bank as a percentage of core capital held. Particularly high capital requirements, however, can also potentially increase the cost of funding as a result of holding higher core capital. These minimum capital requirements may be amended by the Cabinet Secretary for Treasury, subject to the approval of the National Assembly.
In addition, to reduce the potential overexposure of a bank, there is enshrined in the Act the single obligor rule under which a bank is not permitted to lend more than 25 percent of its core capital to any one borrower or any number of related borrowers.
The Act places a limitation on the increase of banking charges without the prior approval of the Minister (Cabinet Secretary for Treasury) under section 44. There is in fact a long-running legal battle between banks and customers over the alleged increase in bank charges without the approval of the Minister.
Section 44A of the Banking Act introduced what has since been called the in-duplum rule in May 2007 by providing that no institution may recover from a debtor an amount of interest exceeding the principal amount when the loan becomes non-performing. The only exception to limitation of interest is with respect to an award made by a court (through a court order). In August 2022, the High Court in Mugure & 2 Others v Higher Education Loans Board (Petition E002 of 2021) [2022] KEHC 11951 (KLR) (Civ) 19 August 2022) (Judgment) at paragraphs 24 and 25 expanded the application of the in duplum rule to other institutions other than banks as to cover all money lenders. This finding was a departure from a 2016 High Court decision in Desires Derive Ltd v Britam Life Assurance Co (K) Ltd (2016) eKLR which held that the in-duplum rule is only applicable to banks. The in duplum rule is captured in other jurisdictions such as South Africa in the National Credit Act No. 34 of 2005 where it applies to all money lending transactions, over and beyond banks. Such a statutory amendment to reflect this position and the recent decision in Mugure, may be appropriate for purposes of consumer protection.[1]Further, the in duplum rule was said to apply retrospectively in Kenya by the Court of Appeal in Kenya Hotels Ltd v Oriental Commercial Bank Ltd (Formerly known as The Delphis Bank Limited) [2019] eKLR.
At present, there is no regulation or cap on the interest rates that may be charged on a loan by banks. This is the case following the repeal of section 33B of the Banking Act (introduced through the Banking (Amendment) Act 2016 passed on 14 September 2016) providing the Central Bank of Kenya with powers to impose interest rate ceilings. The said section had provided that banks and financial institutions shall set the maximum interest rate chargeable for a credit facility at no more than 4 percent above the Central Bank rate and published by the Central Bank of Kenya. This provision had the effect of causing credit rationing as banks and financial institutions shied away from lending to risky borrowers.[2] The law imposing a cap on interest rate chargeable was challenged in the High Court in Oduor v Attorney General & another; Kenya Banker’s Association & 2 others (Interested Parties) [2019] eKLR where the petitioner argued that the said law was discriminatory against banks and financial institutions as it did not apply to microfinance banks, insurance companies, mortgage finance companies and those dealing in Islamic banking and that the law interfered with the mandate of Central Bank in formulating monetary policy. In its judgment, the High Court quashed the said statutory provision for unconstitutionality for being ‘vague, ambiguous, imprecise and indefinite’ and for being discriminatory against banks and financial institutions. The Court however suspended the implementation of the judgment for a period of 12 months (one year) to allow the National Assembly to consider making amendments to the statutory provision. Accordingly, Parliament repealed the interest cap law in November 2019, reverting to a regime where interest rates are contractually negotiated and agreed between lenders and borrowers.
Another important issue is with respect to the interest on a court award that may be levied against a bank or financial institution in favour of a borrower arising from a wrongful exercise of statutory power of sale. There have been incidences where banks and financial institutions have been slapped with hefty awards by courts for the wrongful exercise of statutory power of sale, especially where matters have been litigated in court for a long time.[3] An interesting decision was however issued by the High Court, though not against a bank or a financial institution, in Justus Ogada Agalo v Managing Director Kenya Railways Corporation [2016] eKLR. This decision relied on section 4(4) of the Limitation of Actions Act to hold that the imposition of interest on a decretal sum is limited to a period of six years. Arguably, doubts may be raised as to whether this is the correct interpretation of the said provision, which seems to only provide a bar on timelines within which one can claim interest arising from a court award. The other relevant issue is the applicable rate of interest that may be awarded by a court as against a party or a financial institution. Courts usually issue an award with interest at either court rates (usually interpreted as ‘simple interest’), commercial rates or compound interest rates. Section 26 of the Civil Procedure Act gives a trial court the discretion to award interest at rates it deems reasonable and just. The Court of Appeal in Barclays Bank (K) Limited v William Mwangi Nguruki [2014] eKLR stated that interest rate at court rates is calculated on a simple interest and not on a compounded basis. On the other hand, the High Court in Feroz Nuralji Hirji v Housing Finance Company of Kenya Ltd & another (2015) eKLR explained the circumstances under which a court could award simple interest and compound interest. In paragraph 11, the court stated: “ I should state again that our law on award of interest, does not provide for the method of calculating the interest awarded by the court… An(d) critical analysis of the law and the judicial decisions on this subject in Kenya, there is no prohibition to interest on the principal sum being calculated as compound interest. However, I would state that courts have always proceeded on a presumption that interest awarded by the court should be simple interest unless otherwise ordered by the court. To me the ‘’unless’’ aspect which is pronounced in the decisions I have encountered portend that a court may order interest to be compounded where circumstances allow. It is, therefore, permitted in law to order a post-judgment equitable relief that interest to be calculated on a compound basis where fairness concerns dictate it. The compounded interest acts as recompense to the Plaintiff.”
STATUS/ISSUE
RECOMMENDATION
Fintech has revolutionized the delivery of financial services. Innovations such as digital payment processing solutions have improved efficiency and facilitated financial inclusion and hold great promise in enhancing affordable housing finance.
Encourage the use of fintech by banks. This can be through the adoption of innovative credit scoring systems that uses alternative data to assess creditworthiness. This will translate to persons who would have been termed as high risk under the traditional model, being able to access mortgages.
8.2.2 Mortgage Banks
Section 15 of the Banking Act, 1989 (Cap 488) provides that mortgage finance companies shall make loans for the purpose of acquisition, construction, improvement, development, alteration, or adaptation of a particular purpose of land in Kenya. The repayment of such loans is secured by first mortgage or charge over land with or without additional security or personal or other guarantees. Under section 15(2), a mortgage finance company may grant other types of credit facilities against securities other than land and may also engage in other prudent investment activities.
8.2.3 Building Societies
Building Societies were created to support the delivery of housing
Building Societies Act, 1956 (Cap 489)
Guarantee (House Purchase) Act, 1967 (Cap 462)
Building Societies
STATUS/ISSUE
RECOMMENDATION
The role of building societies has diminished over time and are not currently operational. Family Building Society, Equity Building Society and Housing Finance have all evolved into banks, focusing on broader banking - not just housing.
Consider the relevance of Building Societies and these laws.
Guarantee (House Purchase) Act, 1967 (Cap 462)
Section 3 of the Act allows government to guarantee the repayment of excess advances made or to be made by a building society to citizens of Kenya for the purpose of enabling them to purchase houses within its area of jurisdiction.
Consider repealing this Act, which is not relevant given the diminishing role of building societies.
8.2.4 SACCOs Subsector
CONTEXT
Despite SACCOs overtaking commercial banks and mortgage providers in the provision of mortgage and housing construction loans,[5] now accounting for over 100,000 loans of home finance loans in Kenya, they have limited governance and administrative capacity to deal with. According to a survey by the Sacco Societies Regulatory Authority (SASRA), 36% of outstanding credit in 2016 was for land and housing.[6] The limited governance was largely responsible for the collapse of some SACCOs and the associated loss of funds mostly belonging to low-income households.[7]
A typical SACCO loan product for housing is to provide up to 3x a member’s deposits as a loan, which is co-guaranteed by other members. The loans may also be secured by collateral or shares.
The innovation in the KMRC is certain large SACCOs are included as shareholders who will benefit from the concessional financing to on-lend to their members.
The relevant acts and regulations are:
· Sacco Societies Act, no. 14 of 2008
· Sacco Societies (Deposit-Taking Sacco Business) Regulations 2010
· Sacco Societies (Non-Deposit Taking Business) Regulations 2020
· The Sacco Societies (Amendment) Act 2022
· Sacco Societies (Specified Non-Deposit Taking Business) (Levy) Order 2022
· Cooperative Societies Act, No. 12 of 1997
· National Cooperative Development Policy (draft from 2019)
STATUS/ISSUE
RECOMMENDATION
Despite the inclusion of the need for a Deposit Guarantee Fund in the Sacco Societies Act 2008, it has never been operationalized thereby putting at risk, members’ deposits.
There is a lack of specificity in the Act (and no regulations) on documents needed to lodge a compensation claim; whether inflation is factored in compensation; and management of money/funds in the Fund.
Illiquidity problems in SACCOs limiting inter-SACCO borrowing.
Operationalize the Deposit Guarantee Fund for the SACCO sub-sector in accordance with the law.
There is need for the Act or regulations to be developed to capture some gaps in the law such as: documents needed by a member to lodge a claim; whether the compensation paid from the Fund will consider inflation arising as a result of protracted disputes before settlement/compensation; a gap on how to manage the funds in the Fund; create awareness on the Fund once established.
Fast-track the setting up of the Central Liquidity Fund in the Sacco subsector to promote inter-borrowing among Saccos and deal with potential illiquidity challenges as well as become part of the national payment system.
There lacks a policy to govern the cooperative movement/societies
Fast track the finalization and adoption of the draft National Cooperative Policy
The powers vested on the Commissioner of Cooperatives in the Cooperative Societies Act 1997 appear excessive as they seem to interfere with cooperative principles of “autonomy and independence” by giving the Commissioner powers of control. These risks slowing the growth of the cooperative movement.
Review the powers of the Commissioner of Cooperatives with a view to upholding the principles of “autonomy and independence”.
8.2.5 Mortgage lending
Mortgage lending in Kenya is primarily done through commercial banks and SACCOs. SACCOs are now able to provide more mortgages of longer tenures courtesy of the refinancing they obtain from Kenya Mortgage Refinance Company (KMRC). According to the Central Bank of Kenya’s 2021 bank supervision annual report, outstanding mortgages totalled Kshs. 245.1 billion as of December 2021. The number of mortgage accounts stood at 26, 723 still indicating the low uptake of mortgages in Kenya. In 2021, the average interest rate for a mortgage stood at 11.3 percent compared to 10.9 percent in 2020. However, KMRC offers funds to banks and other financial institutions at five percent interest, which allows them to on-lend their customers long-term mortgages at single-digit, stable interest rates (currently at about 9.5%).
8.2.6 Pension-backed lending
(Please also refer to Section 8.4.2.6 for discussion on taxation issues that arise on the transfer of pension assets into housing).
CONTEXT:
The capital under pension schemes in Kenya equaled Kshs. 1.5 trillion as at December 2021. There have been various efforts to enable pension members to utilize their pension contributions towards housing. However, the uptake of this has been slow, demonstrating the difficulties in unlocking the flow of financing into formal housing, despite strong government efforts to pursue the same.
The relevant laws and regulations are:
· Retirement Benefits Act, No. 3 of 1997
· Retirement Benefits (Mortgage Loans) Regulations, 2009
·Retirement Benefits (Mortgage Loans) (Amendment) Regulations, 2020(Quashed by the High Court on the 23 November 2022)
STATUS/ISSUE
RECOMMENDATION
The 2009 Regulations allowed a pension member to assign up to 60% of their savings as collateral for a mortgage, without withdrawing any funds.
While this is the preferred option for pension funds (as it will not reduce the available pension funds for members to be supported in their retirement and does not reduce or affect their liquidity or provide shocks to their investments), the uptake of this product has been low.
Some hypotheses are the banks in Kenya continued to use the home collateral as the primary source of collateral and did not reduce the interest rate upon receiving additional collateral.
((Lack of supply of affordable housing is also thought to be a contributory factor.))
A review of the pension-backed mortgage market would be useful, to understand and quantify the barriers to uptake. As part of this, the review should study why similar provisions have successfully supported significant home ownership in markets like Canada and South Africa but failed to do so in Kenya.
The 2020 Regulations also allowed for members to access the lower of 40% or Shs. 7 million of their pension savings (both employee and employer portions), plus 100% of additional voluntary contributions made by the employee into housing.
The amount withdrawn could not exceed the value of the building/house. Taxes were applicable upon withdrawal as per Table [x] below, similar to when a member leaves the employer and accesses his/her benefits.
Pension administrators voiced concerns about these regulations; that they could result in sudden and significant withdrawal of pension assets, and lead to substantial disruptions in the capital markets and liquidity challenges for most pension funds. In addition, it may lead to inadequate retirement benefits for the members.
Despite these concerns, there was limited transfer of pension assets into housing in the last 2 years since the regulations were passed as it took time for pension schemes to obtain RBA approvals to amend the scheme’s trust deeds and rules to accommodate these regulations.
There was also a lack of clarity on whether a pension member can utilise savings for housing and simultaneously take a loan for the balance portion, and what taxes would be applied on the transfer of pension assets.
Long and tedious processes and procedures in an application for a house among prospective homeowners also discourage the uptake.
Concerns by pension funds and trustees about the possibility of bleeding the amounts saved by retirees through withdrawals Caveats/limitations/encumbrances placed on the title that limit the disposal of the house once purchased are also discouraging uptake.
In November 2022, the Regulations were quashed and an order was issued against their implementation by the High Court in Republic v National Assembly & 2 Others; Okoiti (Exparte); Retirement Benefits Authority (RBA) & 2 others (Interested Parties) (Judicial Review) (23 November 2022) (Judgement). The Court found that Section 38(1A) of the Retirement Benefits Act and the Regulations were introduced through a flawed parliamentary process and lack of public participation.
Support adequate stakeholder engagement/create awareness to enable the safe flow of pension assets and resolve issues of taxation for withdrawal of funds and obtaining a mortgage as well as utilising pension funds.
This is a clear example of how one initiative of government (to promote the uptake of housing) is undermined by the difficulty of implementation of the provisions enacted. Simplify processes and procedures/reduce the bureaucracy associated with application for housing.
Reintroduce the impugned laws before the National Assembly and follow due process to correct the procedural flaw.
The deadline for amending trust deeds for the 2020 Regulations was 14th September 2021, and it is not clear how many schemes have been able to amend their trust deeds.
Support retirement benefit schemes/scheme trustees to update/amend trust deeds and rules in a standardised manner that can enable safe transfer of pensions into housing.
8.2.7 Microfinance
Microfinance institutions are licensed, regulated and supervised by the Central Bank of Kenya under the Microfinance Act 2006. Microfinance loans are mostly issued to support the incremental building and home improvement process of low-income households. For instance, Kenya Women Finance Trust (KWFT) microfinance bank has been lending to low-income women to build and improve their homes in rural areas. The bank disburses loans in tranches or phases as construction of homes continues for a total of Shs 1 million repayable in a maximum period of three years.
Some of the licensed microfinance banks are set out in this list. However, over the last six years, microfinance banks have consistently posted losses (with only four of them recording profits), largely on account of low uptake of loans and high levels of loan defaults.
8.2.8 Special lending to Government Employees
The Employment Act, No. 11 of 2007 (provides the legal basis for the provision of actual housing to employees or payment of housing allowances in lieu of housing. This is currently provided at 15% of gross salary per section 4 of the Regulation of Wages (General) Order, 1982.
Operationalized in 2004, the regulations indicated a shift in government policy from directly providing subsidized housing to civil servants, (which accommodated approximately 12% of civil servants), to encouraging civil servants to purchase housing delivered by the market, via loans provided by the Civil Servants Housing Scheme Fund. Since its inception, the scheme has facilitated more than 3,000 civil servants to access housing. This has been achieved through housing finance loans or the sale of houses constructed through the Scheme.[8]
STATUS/ISSUE
RECOMMENDATION
Civil Servants (Housing Scheme Fund) Regulations, 2004
The Civil Servants Housing Scheme Fund is an important resource but with a very low rate of disbursement. Between 2015 and 30 June 2021, the Fund gave Ksh 6.2 billion in loans to purchase or build homes to 1, 321 civil servants.[9] Loans provided under the Fund range between Ksh. 4-10 million based on seniority and affordability of the employee. The loan term is the greater of 20 years or the duration before which the civil servant retires. The interest rate is currently pegged at 5% per annum on a monthly reducing balance with applicants being facilitated up to a maximum of 90% of the price upon making a down payment of 10%.[10]
A full review of the Civil Servants Housing Scheme Fund is warranted given the potential impact on housing affordability for civil servants, and the low levels of uptake. In addition, a detailed segmentation of the demand side of civil servants, highlighting housing needs, affordability, borrowing capacity, etc. should be undertaken to ensure that the Scheme is able to reach its stated target.
Explore low disbursement of loans (1,321 loans over more than 15 years)[11]
The composition of the Management Committee of the Civil Servant Housing Scheme Fund is currently top-heavy and not broadly represented by civil servants who are the key actors
Consider reassessing the composition of the Scheme Management Committee of the Civil Servant Housing Scheme Fund as set out in the Regulations to ensure that they represent the civil servants and is not unnecessarily top-heavy.
Housing Scheme Fund Regulations, 2018 (Legal Notice No. 238 of 2018) (Quashed by the Court)
The Regulations sought to mandate all employers to register with the Housing Fund and contribute to the Fund; Establishes a Fund to promote an affordable housing scheme. These regulations were however quashed by the court for lack of public participation.
For a more detailed analysis of the regulations see here.
[1] Notably, section 38(8) of the Tax Procedures Act 2015 and section 16(4) of the Rating Act (Cap 267) already embody the in duplum rule with respect to tax liability claims and property rates claims.
[2] Central Bank of Kenya, ‘The Impact of Interest Rate Capping on the Kenyan Economy: Highlights’ March 2018 <https://www.centralbank.go.ke/wp-content/uploads/2018/03/Summary-of-the-study-on-Interest-rate-Caps_February-2018.pdf>
[3] See e.g. Sam Kiplagat, ‘Family awarded Sh1.2bn against HF in botched home auction’
[4] The Court stated “…He is also entitled to interest on that decretal sum (judgment sum and costs) together with interest at 14% per annum up to a period of six (6) years as Section 4(4) of the Limitation of Actions Act makes it clear that no arrears of interest in respect of a judgment debt may be recovered after the expiration of six years from the date on which the interest became due. Accordingly, I direct that an order of mandamus do issue compelling the respondent to pay the decretal sum together with interest at 14% per annum from the date of the judgment up to a period of six years but no more.”
[5] Davina Wood, “The Role of Savings and Credit Cooperative Organisations in Kenya’s Housing Finance Sector” (UrbanetJune 11, 2019)
[6] SASRA, The SACCO Supervision Annual Report The annual statutory report on the operations and performance of Deposit-Taking SACCO Societies (DT-SACCOs) in Kenya
[7] Thursday, March 07 2019, “Gakuyo Faces DCI Probe over Sh1bn Ekeza Sacco Scandal” (Business Daily December 21, 2020)
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