Why new loans pricing formula signals no relief

This week, the Central Bank of Kenya’s Monetary Policy Committee met to review market developments and the outcomes of its previous monetary policy decisions.

But a new addition to the bank’s monetary policy pronouncements on Tuesday was the setting of the Kenya Bank’s Reference Rate (KBRR) at 9.13 per cent.

However, it is vital to note that KBRR is not a monetary policy tool; but was part of a number of key recommendations by the Cost of Credit Committee that had been constituted and chaired by the National Treasury to explore ways of deepening private sector credit and mortgage finance penetration.

According to the Central Bank, the reference rate is computed as an average of the CBR and the weighted two-month moving average of the 91-day Treasury bill rates.

The overall expectation is that this new pricing regime will make credit more affordable and spur credit growth. However, there are three key salient factors to put into consideration as this new pricing formula takes effect.

First, 60 per cent of total outstanding credit to the economy is to corporate and mid-sized businesses. These are customers who are already borrowing either at discount or at par.

Personal lending, which is the main target of the new pricing regime, accounts for 40 per cent of total credit. Out of this 40 per cent, back-of-the-envelope calculations suggest that up to 90 per cent borrow on variable-rate pricing basis, which translates to roughly 30 per cent of total outstanding credit.

Generally there are two types of pricing: fixed rate pricing and variable-rate pricing. The former is where your borrowing rate is fixed at a certain level for the duration of the loan while the latter is where your borrowing rate is subject to upward or downward adjustments, depending on market conditions.

So this effectively implies that only one-third of outstanding credit facilities will stand to be affected by the new pricing formula.

This may not easily deliver the psychological influence for the market to adjust downwards. Secondly, Kenya, just like many of its sub-Saharan Africa (SSA) peers, is an exchange-rate driven economy rather than interest-rate driven.

This is because most of SSA’s economies, Kenya included, are very much import-driven. February 2014 data from the Kenya National Bureau of Statistics showed that the country’s overall export-import ratio stood at 40 per cent.

These are highly unfavourable trade statistics. To this extent, the Central Bank will always prioritise exchange rate stability because it has direct impacts on consumer prices.

If, for instance, inflation hits double-digit figures, money market liquidity tightens and the shilling loses ground against the US dollar in the region of one to three per cent, the bank will not hesitate to increase its benchmark rate, as a policy response. This kind of policy move will definitely result into upward adjustment of KBRR.

Finally, KBRR only harmonises one aspect of banks’ pricing models-which is base rate setting, and may not necessarily mean lending rates will immediately drop.

The new formula has not taken away banks’ ability to price borrower risks, funding costs and operating costs (all of which still lie within banks’ discretion) and will all be front-loaded on the K bit of the formula (remember effective July 8, banks will now be pricing their flexible rate loans using the formula “KBRR+K”, where K is a premium to be loaded on the reference rate and is dependent on various factors).

However, it is generally expected that, in the long term, the K will be a matter of internal efficiencies.