The Central Bank of Kenya has begun approving lenders’ applications to increase the cost of loans based on customer risks, setting the stage for expensive credit for small traders and workers in the informal sector.
Equity Bank #ticker:EQTY is the first lender to publicly reveal that the CBK has approved the risk element in its lending formula, pricing its loan at between 13 percent and 18.5 percent compared to the current average of 13.5 percent.
Multiple bank executives had last protested to the International Monetary Fund (IMF) over the CBK’s reluctance to approve their applications to raise the cost of loans following the scrapping of interest rate controls on November 7, 2019.
Banks have been eager to price loans to different clients based on their risk profile but this flexibility remained a mirage after the CBK stepped in as the de facto controller of cost of credit.
Equity Bank on Monday said the regulator had approved its risk lending models following two years of talks, indicating CBK has now started allowing banks to gradually raise rates.
“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,” Equity Bank chief executive James Mwangi said.
“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.”
Mr Mwangi said the new pricing model will have base of 13 percent, which matches the average rate charged on government bonds of over five years
Small businesses will get loans at between 14 percent and 16 percent rate from Equity Bank while unsecured loans will attract as much as 18 percent.
“There are corporates like the blue chip firms which will be able to get as low as the sovereign rates. those with higher risk will go all the way to 16 percent, then there is the SMEs from 14 percent to 16 percent. The unsecured individual lending micro, small and medium enterprises from 16 percent to 18 percent,” Mr Mwangi added.
Other tops banks such as Cooperate Bank #ticker:COOP , KCB Group #ticker:KCB and NCBA Group #ticker:NCBA remained tightlipped on their applications to the CBK for review of their lending rates. Bankers fret talking publicly for fear of CBK reprisals.
“Getting approval is a nightmare. CBK has taken a more customer protection approach as opposed to the industry needs,” a bank CEO told the Business Daily in an earlier interview.
Banks say that the delayed shift to risk-based lending has forced many of them to deepen investment in government securities and restrict lending to high-quality customers with a lower risk of default.
This emerged at a time supply of loans to the private sector grew 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 IMF.
“Banks’ holdings of government securities stand at a relatively high 31 percent of assets and are expected to rise further in the coming year.”
The IMF says that Kenya’s lending rates have remained little changed when compared to the period the State controlled bank loan costs.
The lending rates averaged 12.38 percent in November 2019 when the rate cap was repealed, with the Central Bank Rate (CBR) then at 8.5 percent.
In January, lending rates averaged 12.12 percent.
To play it safe, banks have slightly cut the average lending rates in line with the reduction of the CBR, which has been lowered to seven percent, underlining the conundrum lenders find themselves in.
The government removed the cap after it was blamed for curbing credit growth during its three years of existence.
Banks use a base rate that is normally the cost of funds, plus a margin and a risk premium, to determine how much they should charge a particular customer.
The cap, which set rates at four percentage points above the central bank’s benchmark lending for all customers, had taken out that equation and the flexibility that lenders say they need to accommodate customers deemed as risky borrowers.
The inability to price risk in lending is shutting out many prospective borrowers as banks seek to reduce their exposure from already large defaults brought by the Covid-19 pandemic.
The banking regulations of 2006 require banks to seek the CBK’s nod when changing features of any products, including loans.
“Any change in the features of the product changes the product as earlier approved and, therefore, the changed product with less, more or otherwise varied features must be approved by the CBK prior to rollout,” the CBK reminded banks in a 2016 circular.
The CBK has repeatedly warned banks against reverting to punitive interest rates of more than 20 percent in the post-rate cap regime and wants every lender to justify the margins it puts in its formula.