Capital Markets

Why banks are yet to fully apply risk-based lending


The Central Bank of Kenya, Nairobi. FILE PHOTO | DENNIS ONSONGO | NMG

The delay by banks to transition fully to risk-based loan pricing has hampered the transmission of the Central Bank of Kenya (CBK) monetary policy.

The logjam on risk-based pricing has arisen primarily from lack of a broad-based approvals by the CBK to individual banks’ risk-based pricing models, where only 33 banks have had the green light to factor in the likelihood of loan default.

Read: Banks take gradual steps to risk-based lending

About five banks were yet to get the approvals for risk-based pricing as of May.

“The transmission of monetary policy is weak because out of the 39 banks, only about 60 percent of the entire loan book is priced based on risk. This means the pricing of credit is still largely operating in the previous regime with no leeway to implement higher interest rates for riskier and even existing borrowers,” Kenya Bankers Association director of research and policy Samuel Tiriongo told the Business Daily.

The CBK dictates the direction of interest rates primarily through that influences both the demand and cost of credit.

The tightening of monetary policy (raising the CBR), for instance, tappers credit demand by raising interest rates while the inverse increases the demand for credit by lowering the cost of loans.

The lack of industry-wide adoption of risk-based pricing has presented structural challenges to CBK’s policy transmission, weakening the apex primary mandate of price stabilisation.

Despite receiving approval for risk-based pricing, most banks are yet to implement the formula, fearing that raising rates would hand competitors an advantage.

Read: Absa sets sights on unveiling risk-based loans in second half

“When the entire industry has not transitioned fully into risk-based pricing, it becomes a challenge because when one has the power to implement higher rates and the other can’t, the one with the power won’t exercise it as they fear their rates would become unfavourable,” added Dr Tiriongo.

Recent attempts to modernise monetary policy by the CBK have been successful in as far as targeting the short end of the yield curve.

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