Last week, the Central Bank of Kenya (CBK) published revised risk based pricing model for bank loans, establishing a new common reference or base rate that lenders will apply for credit purposes.
The new reference is based on the overnight interbank rate that is a major component of the cost of funding for banks, and which is closely linked to the Central Bank Rate through which the CBK transmits its monetary policy.
The Business Daily talked to CBK governor Kamau Thugge on why the banking regulator reviewed the risk based pricing regime, its impact on the banking sector and enforcement measures on banks that fail to fully comply.
What exactly is changing in the pricing model, and why was it necessary to do the overhaul?
The difference is that the banking sector will now have a common reference rate to price loans – the Kenya Shilling Overnight Interbank Average (KESONIA), which is derived from the overnight interbank rate.
With a common reference rate it will be easier to take on non-conforming banks, unlike when each had its own base for pricing loans.
There will be surveillance from the Central Bank to make sure that banks are implementing the new model. The idea is that within 15 days after the board approval of their models, banks will send those details to the Central Bank and that will be the basis for subsequent engagement to see whether they are following up on what they have submitted to their boards.
In the operation of the older Risk Based Credit Pricing Model, we realised that it had major shortcomings and was not very transparent. We also realised that it was biased towards the banks and against borrowers.
When it was necessary to raise rates, banks did so very quickly. However, when we lowered the benchmark rate, it took some time for banks to lower their rates.
How does the new model ensure that, unlike its predecessor, banks will actually transmit monetary policy signaling as the Central Bank adjusts its rates?
In our new monetary policy framework, we have ensured that the Interbank Rate very closely tracks the Central Bank Rate. The moment we lower the CBR, the next day the Central Bank will do its open market operations and makes sure that KESONIA, on which loans are priced, is aligned to the CBR, via the interbank rate.
The banks will then be required to immediately adjust their lending rates accordingly. So, when we lower the rates, we know banks will now have to lower their rates without delay.
Six months ago, the CBK introduced on-site inspection of banks to monitor banks’ transmission of interest rate cuts to customer loans. Should we expect this to change under the new Risk Based Credit Pricing Regime?
I think it will change very significantly.
We did on-site inspection of all banks and those inspections were really to see how and whether the banks were following their credit pricing models. The results were not very encouraging and this is also part of the reason why we are overhauling the whole Risk Based Pricing system.
In fact, some banks were not even following the models we had agreed on with them and of course now we are in the process of assessing whether there will be penalties and how much those penalties will be.
There are some concerns that there may be too much weight on the borrower’s risk premium under the new pricing model. Is there any further guidance the CBK will be giving around the weighting of each of the components in the formula?
This framework is not about controlling rates because when we tried to control rates, the opposite of what we wanted actually happened and we ended up getting less credit into the private sector.
So we want to leave premium for the banks to determine so that if a borrower’s credit risk is higher, this premium is imposed accordingly.
What’s the latest regarding the tender floated for supply of a Retail Bond System, which is expected to embed a user interface and a retail depository system? How soon before we see it rolled out?
We are just going through the procurement process now and I hope we will be able to complete within this financial year and to have that Retail Bond System in place. It’s just part of deepening the financial markets.
Last year we funded the government to the tune of Sh850 billion, I don’t think we have ever done that before. The situation going forward is that Official Development Assistance is declining and of course we have had some challenges with some of our bilateral and multilateral partners and there are difficulties in mobilising revenue.
So, we need to have a deeper market on which government can rely without driving up interest rates and crowding out the private sector.
As per the schedule, we are supposed to have IMF Article IV Consultations happening this month. Any update on that?
Yes, there were supposed to be Article IV Consultation discussions in September— which is the routine engagements between the IMF and Kenya to review the country's economic and policy framework.
Our preference was that we start the discussions on the new funding programme in September before the Article IV Consultations.
Once we have concluded with the programme discussions and the programme goes to the board, we can then have the IMF consider both the Article IV and the programme itself.
