Change in law opens window for rise in cost of bank loans

Commercial banks will be allowed to charge higher interest on customer loans based on their assessment of default risk in proposed amendments to the controversial rate cap law.

The new loan pricing model proposed by Gatundu South Member of Parliament Moses Kuria will allow banks to raise the cost of loans up to six percentage points above the Central Bank Rate (CBR) from the current four percentage points.

The benchmark rate now stands at nine percent, implying the draft law would set the stage for an increase in loan charges from the current 13 percent to 15 percent.

The draft legislation, however, proposes the retention of the four percentage points ceiling on loan charges above the CBK base rate for “low risk” borrowers.

“I wish to introduce an amendment to the Banking Act to introduce a risk negotiation window of up to six percent above the lending cap for SMEs and unsecured individuals to negotiate pricing based on their risk profile and on a willing buyer, willing seller basis,” said Mr Kuria in a letter dated 14th January 2019 to the Speaker of the National Assembly, Justin Muturi, while introducing the content of his Bill.

Kenya introduced interest rate controls in September 2016 with the enactment of a law that limits lending rates to not more than four percentage points above the CBR in response to the high cost of credit that saw banks lend to private businesses and individuals at more than 20 percent.

Private sector credit

The rate cap was aimed at helping borrowers access capital at affordable rates, but has had the opposite effect, with banks saying they cannot price risk to small and medium enterprises (SMEs) properly while the cap is in place.

CBK data shows private sector credit grew by 4.4 percent growth in the 12 months to October — compared to September’s 3.9 percent.

The credit growth remained well below the central bank’s target rate of 12-15 percent.

“The amendment will go a long way to free credit to the SMEs, discourage government borrowing from the domestic market, drive private sector growth and spur fresh economic activity and growth,” said Mr Kuria.

The lenders lobby group, the Kenya Bankers Association (KBA), welcomed Mr Kuria’s draft legislation, saying it would unlock credit to small businesses and households presently being shunned by banks.

“We generally welcome any legislative proposal that comes in to unlock credit to the SMEs and households,” said KBA chief executive Habil Olaka.

Mr Kuria’s proposed amendment, however, also elicited opposition, with some saying banks will abuse the risk component to inflate the cost of loans.

Kiambu Town MP Jude Njomo, the architect of the rate capping law, slammed the proposals and vowed to marshal his colleagues to reject any amendments to the Act.

“Banks will classify every customer as risky if you open that window for them,” said Mr Njomo when contacted. “I will oppose this amendment vehemently.”

The Consumer Federation of Kenya (Cofek) said the proposed pricing model amounts to giving banks the leeway to set own high rates.

'Not objective'

“Banks are not objective…in the event the Speaker allows the amendment, we urge MPs to unanimously vote against it,” Cofek secretary-general Stephen Mutoro said.

But Mr Olaka argued that under the proposed legislation “banks will compete so a customer will move to the next bank if offered higher rates.”

According to Deepak Dave, a risk management expert with Riverside Capital Advisory, the proposed legislation “is a sensible suggestion that allows for differential risk trends and patterns.”

“But it is crucial to get the language right and apply the rule across the spectrum to all players,” said Mr Dave.

Banks have argued that they are unable to properly price in risk for customers, especially SMEs that tend to carry a higher default rate.

They have consequently pumped more money into government securities even as they tightened credit to private enterprises and individual customers, according to industry data.

In May last year, the National Treasury announced it was mulling a scheme to guarantee commercial bank loans to SMEs as part of the effort to reduce their risk profile, keep loan prices low and ease access to credit.

“The credit guarantee scheme is a policy tool to direct credit to SMEs thus contributing to sustainable economic development and job creation,” Treasury principal secretary Kamau Thugge said then.