KBA endorses CBK move to reintroduce risk-based lending
Some banks in Kenya are in final preparations to submit their documents to the Central Bank of Kenya (CBK) which has started approving applications for a risk-based lending rate model after a two-year delay.
They received a knee-jerk from the Kenya Bankers Association (KBA) which is supporting the model as a viable solution to short- to medium-term inflationary threats.
”Yes, we support the loan pricing model. Each lender presented its plan to the regulator for review,” said KBA Chief Executive Officer Habil Olaka.
This, however, sets the stage to increase the cost of loans based on customer risks, therefore, expensive credit for small traders and workers in the informal sector.
The first lender in the country to have received a nod from CBK was Equity Bank after it was granted the application to price loans at between 13 to 18.5 percent.
Equity Bank Group CEO Dr. James Mwangi said the new pricing mechanism clears the path for lenders to accommodate everyone irrespective of their risk, unlike during the interest rate cap regime.
Equity’s computation of a single interest rate was arrived at using an opportunity cost approach, where, it considered the rate the state pays for its loans as a risk-free entity and then added on its operational and credit risks to arrive at the final price.
“Interest on loans will now be based on the risk of the client. We are using sovereign risk as the base, then adding the risk of the individual sector and then within the sector the specific client risk and then we add operational costs,” said Dr. Mwangi.
“So instead of the previous [pricing model] where we had loan appraisal fees, and all the rest, we are now saying here is one rate of interest and it is annualised and on reducing balances. We have simplified and removed the fees and combined the rate into one based on the sovereign risk,” he added.
Last July, CBK Governor Dr. Patrick Njoroge said that the regulator had assessed the models of lenders and approved many while sending others back for revision.
He said part of the discussion involves an explanation of factors that determine the pricing of loans such as the cost of funds, return on assets, operating costs and the risk premium relative to the non-performing loans.
“We had those conversations with them and we have moved on with a lot of these banks. There have been some that had not done their work well so we asked them to revise,” said Dr. Njoroge.
The International Monetary Fund (IMF) was initially opposed to the idea and only changed its position on the risk-based pricing model after intense lobbying.
Kenya has been working on a risk-based loan pricing model since repealing the interest capping law in 2019.
Lenders are said to have complained to IMF officials about CBK’s hesitation in approving the model
Risk-based pricing occurs when lenders offer different consumers different interest rates or other loan terms, based on the estimated risk that the consumers will default.
The delayed shift to risk-based lending has forced many of the banks to deepen investment in government securities and restrict lending to high-quality customers with a lower risk of default.
This came against the backdrop of increased lending to private sector up by 8.6 percent in the year to December 2021, which is below the ideal rate of 12-15 percent needed to support economic growth.
“With an ample capital position and strong deposit growth, banks are positioned to extend credit to the economy to support the recovery, though they may face some headwinds,” said the International Monetary Fund (IMF).