Banks defy CBK, load profit margins on cost of loans

Nearly all of Kenya’s 46 commercial banks are in breach of a deal they struck with the Central Bank of Kenya (CBK) requiring them not to include profit margins in the premiums they add to the standard base lending rate, frustrating the regulator’s efforts to bring down the cost of loans.

A new CBK report on the lending market shows that profit margins constitute a fifth of premiums charged on loans, making a mockery of the regulator’s quest to tame rising lending rates using the recently introduced Kenya Banks Reference Rate (KBRR).

“Although the value of the premium ‘K’ above the KBRR should depend on the lender’s perception of customer-specific risk profile, sector-specific risks, speed and cost of collateral perfection at the Lands Registry, and other costs arising from the due diligence processes, the February 2015 Survey shows that banks have included other factors,” says the report based on a recent CBK survey.

The base rate was introduced last in an effort to ward off political pressure that sought to fix lending rates in law.

This is the first time that the central bank has broken down the elements that constitute commercial bank rates as it seeks to enforce transparency in the loan pricing market.

Banks attribute 30 per cent of their premiums to administrative costs, 27.8 per cent on risk of default and 10 per cent to process of registering an asset as a security to a loan.

Profit margins, now standing at an average of 21 per cent of the premiums, constitute the other factors referred to by the CBK. Non-defined factors constitute nine per cent of the premiums.

Under the new pricing model interest rates are broken down into two parts — the base rate, commonly referred as the KBRR, which is set by the CBK, and the premium, referred to as K, which is left at the discretion of each bank.

“We expect banks to vary their lending rates as close as possible to the KBRR,” the central bank has emphasised in each of its monetary policy committee meeting briefs. The KBRR is currently set at 8.54 per cent.

The CBK survey, however, found that banks are loading premiums larger than KBRR, a practice that it partly blames for the persistence of high interest rates.

READ: Banks defy new loan pricing tool to rake in Sh141bn

Currently, loans to small and medium-sized enterprises are priced at an average 20 per cent, including KBRR (8.54 per cent) and a premium of 11.5 per cent.

The CBK says the removal of the extra elements such as profit and other unclassified elements would leave the lending rate at 3.3 percentage points lower than the current average.

The premium on personal loans stands at an average 10 per cent, pushing the total interest rate charged to an average of 18.5 per cent.

The lenders have faulted the central bank’s position on premium pricing, arguing that they need to allocate profit margins which are not included in the base rate calculation.

“This is still under discussion. The discussion is that K (the premium) should include the profit element because there is nowhere else to put it — KBRR can’t accommodate the profit element,” said Habil Olaka, the chief executive of Kenya Bankers Association (KBA).

The KBRR is calculated as an average of the government borrowing rate as expressed in the 91-day Treasury bill and the Central Bank Rate – which is the policy rate.

It includes the cost of deposits because large depositors usually challenge banks to match the government rate to attract their funds.

Banks pay less than two per cent interest on retail customer deposits while current accounts operated by businesses do not attract any interest.

Last year, banks paid Sh90 billion for their customers’ Sh2.3 trillion deposits, fixing the cost of funds at an estimated four per cent against the then KBRR of 9.1 per cent.

Mr Olaka, however, maintained that the cost of funds was different for each bank and was mostly determined by the sources of deposits. Those who relied on wholesale depositors, however, incurred higher costs, he said.

The survey found that foreign banks have a higher weighting of profits at 22.5 per cent compared to their local counterparts who had an average weighting of 21.3 per cent.

Kenyan banks have been accused of overpricing loans to rake in profits without regard to the negative impact the high cost of financing exerts on the rest of the economy.

Large interest spreads have been identified as the main cause of the high cost of loans forcing the government, which is against regulation of interest rates by law, to constitute a committee of experts to tackle the issue.

The committee, which consists of two former chief executives of banks, who are currently serving as Cabinet secretaries, KBA representatives and the CBK, recommended introduction of KBRR.

Interest rates have dropped marginally since the introduction of the standardised pricing strategy and were priced at 15.1 per cent in January from 15.7 per cent during a similar month last year.

The new rules require banks to migrate all loans to the KBRR pricing mechanism by end of June this year. Some Sh719.8 billion of existing loans had been converted to the KBRR framework by end of January.

Last year, banks reported a total profit of Sh140.9 billion up from Sh124.3 billion in 2013 or a 26.6 per cent return on shareholders’ investment.
That outcome left the lenders with the highest returns globally despite the drop from the previous year’s 28.8 per cent.

A stress test on 31 banks in the United States found they had an average return on equity of eight per cent while in Europe banks returned 4.6 per cent to equity, according to data from the European Central Bank.

A 2012 World Bank research showed that 48 per cent of the interest spread — the difference between the rate paid by a bank for deposits and what it charges those who borrow the savings — was attributable to profits with operating expenses taking 40 per cent.