The Central Bank of Kenya wants every bank to review its loan pricing criteria by considering their relevance in the current economic environment. PHOTO | FILE
The Central Bank of Kenya has introduced tough conditions for setting lending rates, dimming banks hopes of raising interest rates at will after the repeal of the contentious interest rate law in November last year, which had capped lending rates at four percentage points above the prevailing Central Bank Rate (CBR).
The EastAfrican has learnt that while banks have been demanding the freedom to price loans based on the risk profiles of individual customers, CBK is not comfortable with the cost and profit margins banks are factoring into the overall price of loans.
This loophole, the regulator argues, could be exploited by lenders to revert the economy to a regime of the higher interest rates prevailing before rate caps were enforced in September 2016.
Concerned with the risk of sliding the economy into a higher interest rate regime, the CBK has directed that all banks develop loan pricing models or formula which have to be reviewed and approved by the regulator to guide the process of setting lending rates.
Through a Banking Sector Charter (2019) CBK instructed banks to quickly shift to towards customer-centric, risk-based loan pricing and transparency to ensure banks don’t arbitrarily raise lending rates and harm borrowers.
However, the new policy which is set to suppress the net interest margins (NIMs) for individual banks and overall profitability, has prompted banks to reduce lending to the productive sectors of the economy and channel billions of dollars into risk free government securities.
RELEVANT FACTORS
CBK data shows that after the repeal of rate caps on November 7, 2019, total banks’ investment in government securities jumped 24 per cent to Ksh1.12 trillion ($11.2 billion) in June 30, 2020, from Ksh903.9 billion ($9.03 billion) on November 30, 2019.
On the other hand, lending to the private sector increased at a slower rate of 3.6 per cent to Ksh2.69 trillion ($26.9 billion) from Ksh2.6 trillion ($26 billion) in the same period.
The banks’ new loans pricing model, which is currently a subject of discussion between lenders and the regulator requires banks to price loans based on factors considered ‘relevant’ to the prevailing economic environment.
The banks, through their lobby group the Kenya Bankers Association (KBA) said the loan pricing models for individual banks are constantly reviewed by the Central bank to ensure they are efficient in pricing customer loans.
“This discussion is ongoing between the banks and the Central bank. Some banks have fairly sophisticated models while others do not but the critical thing is to demonstrate that customer risk profiles are taken into consideration in the pricing rather than it being arbitrary,” Habil Olaka, the association’s chief executive told The EastAfrican.
“Banks are developing models to differentiate a client’s pricing based on assessment of risk. So the model may not have been approved but meanwhile you are trying to demonstrate that the one you have differentiates the risk profile of the customer,” Dr Olaka added.
“The discussion with Central bank for example may point out some areas of weakness or of concern which will then continuously be worked on to improve. It is a fairly dynamic kind of model where you continuously refine and based on the data you get from the market you keep improving on it to ensure it captures all elements it needs to. So it is a continuous process where you get feedback from CBK in terms of which are the areas of weakness or concern, address these and adjust the model accordingly,” Dr Olaka said.
RELEVANCE TO PRICING
A chief executive of a top bank who declined to be named because of the sensitivity of the matter said that CBK wants every bank to review its loan pricing criteria by considering their relevance in the current economic environment.
“With the engagement of the Central bank we are fine-tuning our models to ensure they address not just risk profiles of customers but whatever elements affect the price. Those are the discussions we expect early conclusions on. Obviously they want us to make sure we understand our cost and thinking about their relevance in pricing,” the banker said.
The Consumer Federation of Kenya (Cofek) demanded the gazettement of the regulatory parameters in the proposed risk pricing model to ensure borrowers are not exploited by the respective banks.
“As a regulator, CBK has failed to provide watertight regulatory environment. When there are no clear regulatory parameters for instance on risk pricing models, borrowers will remain at the mercy of the bankers on applicable rate,” said Stephen Mutoro, secretary general of Cofek.
“The balance between the interest of bankers and that of consumers must be struck. This is indeed the weakest link. Risk pricing of loans is indeed a major risk to itself if its guidelines are not gazetted.”
CBK Governor Patrick Njoroge was not available for comments as there was no response to our e-mailed questions by the time of going to press.
Analysts at EFG Hermes expect lower than expected growth in banks’ performance this year largely due to delays by Central bank to approve the risk pricing models and the heightened political risks fuelled by the rising clamour for constitutional change through the Building Bridges Initiative.
KNBS STATISTICS
“In contrast to our expectations at the end of 2019 (immediately after the rate caps were repealed) banks’ net interest margin have continued to shrink in the 2020 financial year due to a combination of declining asset yields and the banks’ inability to reprice loans as the CBK mandated all banks to develop a risk pricing model to determine lending rates rather than setting arbitrary rates for the same,” the analysts said in their latest market report last week.
It is feared that banks’ depressed lending to the productive sectors of the economy could stifle the recovery of an economy largely battered by Covid-19.
Data from the Kenya National Bureau of Statistics shows that Kenya’s economic performance declined by a record 5.7 per cent during the three months period to June 30, 2020, compared with a growth of 5.3 percent in the same period last year with virtually all key economic sectors save for agriculture and financials grinding to a near halt fuelled by the Covid-19 pandemic.
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