CBK’s new ‘K’ factor rule to streamline creditworthiness

In Kenya, this conduct and interest rate rules is regulated by the Central Bank of Kenya (CBK). This month, the CBK has announced a major policy shift that will affect both commercial banks and their borrowers.

The shift has provided new guidance on how interest rates will be determined going forward. Under the new framework, all commercial banks are required to price their loans based on a common base rate, anchored on the prevailing interbank rate, plus a borrower-specific risk premium referred to as the ‘K’ factor. 

By introducing the ‘K’ factor, the CBK is directly addressing one of the most stubborn problems in Kenya’s financial sector, and which has been responsible for the rising non-performing loans (NPLs): strategic default.

For years, interest rates have been broadly standardised, often based on loan type, tenures and maturity, or collateral, but with little reflection of individual borrower behavior.

As a result, borrowers with strong repayment records were priced the same as those with poor track records. Worse still, some borrowers with the ability to pay have deliberately defaulted, knowing there were limited consequences.

This behavioral pattern is captured in the Strategic Default Theory, famously articulated by economist Hayne Leland. According to Leland, default is not always caused by financial hardship. Sometimes, it's a calculated decision.

If the benefits of default—are perceived to outweigh the costs, some borrowers will choose to walk away from their obligations.

In Kenya, the current NPLs rate of 17.6 percent cannot be explained by economic hardship alone. Many lenders and borrowers know this first-hand. Anyone who has extended credit has likely encountered the now-infamous shrug: “Uta-do?” a growing culture of impunity.

With this new directive, the era of casual default is coming to an end. At its core, the ‘K’ factor is derived from the global standard for measuring credit risk: Expected Credit Loss (ECL). ECL is calculated using three components, Probability of Default which is the likelihood that a borrower will fail to repay, based on past credit behavior and current credit score.

Loss Given Default, which is the portion of the loan that a lender expects to lose if a default occurs, and Exposure at Default, which is the expected loan balance at the time of default.

This means every borrower's ‘K’ factor will vary—reflecting their unique creditworthiness. High-risk borrowers will pay a higher rate; low-risk borrowers, a lower one.

Thanks to Credit Information Sharing frameworks and the growing availability of real-time credit scores, borrowers now have access to the data that informs their own risk profile. We will soon see ‘K’ Factor Calculator, to be used by consumers to estimate their expected interest rates, which they can then use to negotiate fairer loan terms.

With such tools, borrowers will come face to face with the reality of having a bad credit history.

This move by CBK will not only punish bad borrowers, but it will introduce transparency, accountability and competition into loan pricing.
In my view, this policy represents the most significant market-oriented reform since the removal of interest rate caps in 2019.

Importantly, it tackles the long-standing problem of information asymmetry. When borrowers can see and understand the pricing of their loans—including the variables that influence it—they can challenge unfair rates, improve their behavior and shop competitively.

Over time, this will push financial institutions to sharpen their pricing models, while giving consumers the power to shape their own cost of credit. Instead of relying on heavy-handed regulation such as capping interest rates or a limiting risk-based pricing model, the CBK is trusting market forces to deliver efficiency.

With time, lenders will compete for top-tier borrowers with attractive pricing, while those with weaker credit profiles will have clear incentives to improve. The ‘K’ factor not only addresses the structural causes of non-performing loans; it also mainstreams creditworthiness as a central element of loan pricing.

This move is good for lenders, good for responsible borrowers and good for the economy. It addresses the structural causes of NPLs and mainstreams creditworthiness and financial probity.

The writer is CEO, Metropol Credit Reference Bureau