- Equity Bank is the first lender to publicly announce that CBK has approved the risk element in its loan formula, pricing its loan at between 13 percent and 18.5 percent.
- Banks have sought to price credit to different customers based on their risk profile, but this flexibility remained a mirage after the CBK stepped in as the de facto controller of the cost of credit.
- Small business loans are getting between 14 and 16 percent from Equity Bank, while unsecured loans are attracting up to 18 percent.
The Central Bank of Kenya has begun approving lenders’ requests to increase the cost of credit based on customer risk, setting the stage for expensive credit for small traders and informal sector workers.
Equity Bank #ticker:EQTY is the first lender to publicly announce that the CBK has approved the risk element in its loan formula, pricing its loan between 13 percent and 18.5 percent from the current average of 13.5 percent.
Several bank executives had protested at the International Monetary Fund (IMF) late in the year over the CBK’s reluctance to approve their requests to raise borrowing costs after interest rate controls were lifted on November 7, 2019.
Banks have sought to price credit to different customers based on their risk profile, but this flexibility remained a mirage after the CBK stepped in as the de facto controller of the cost of credit.
Equity Bank said on Monday the regulator had approved its bad debt schemes after two years of talks, suggesting the CBK has now started allowing banks to gradually hike rates.
“Loan interest is now based on the risk of the customer. We use sovereign risk as a basis, then add up each sector’s risk and then within the sector, customer specific risk, and then add operational costs,” Mr Mwangi said.
“So instead of before [pricing model] where we had loan appraisal fees and all the rest, now let’s say this is an interest rate that is annualized and reduces balances. We simplified and eliminated the fees and consolidated the rate into one rate based on country risk.”
Mr Mwangi said the new pricing model will have a base of 13 percent, which is the average interest rate on government bonds over five years
Small business loans are getting between 14 and 16 percent from Equity Bank, while unsecured loans are attracting up to 18 percent.
“There are companies like the blue chip that will be able to get as low as government interest rates. those with higher risk will go up to 16 percent, then there are the SMEs from 14 percent to 16 percent. Unsecured individual lending to micro, small and medium-sized enterprises from 16 percent to 18 percent,” Mr Mwangi added.
Other top banks such as Cooperate Bank #ticker:COOP , KCB Group #ticker:KCB and NCBA Group #ticker:NCBA have been reluctant to request CBK to review their lending rates. Bankers resent speaking publicly for fear of CBK reprisals.
“Getting approval is a nightmare. CBK has taken a stronger customer protection approach in contrast to industry requirements,” said a bank CEO Business Daily in a previous interview.
Banks say the delayed shift to risk-based lending has forced many of them to step up their investments in government bonds and limit lending to high-quality customers with a lower risk of default.
This comes at a time when the supply of credit to the private sector increased by 8.6 percent in the year to December 2021, below the ideal rate of 12-15 percent needed to support economic growth.
“With adequate capitalization and strong deposit growth, banks are positioned to lend to the economy to support the recovery, although they may face some headwinds,” the IMF said.
“Banks’ holdings of government securities are a relatively high 31 percent of assets and are expected to increase further in the coming year.”
The IMF says Kenya’s lending rates are little changed compared to when bank borrowing costs were controlled by the banks.
Lending rates averaged 12.38 percent in November 2019, when the interest rate cap was lifted, and the Central Bank Rate (CBR) was 8.5 percent at the time.
In January, lending rates averaged 12.12 percent.
To be on the safe side, banks have cut average lending rates slightly in line with the cut in the CBR, which was cut to seven percent, underscoring the dilemma facing lenders.
The government lifted the cap after it was accused of slowing credit growth during its three-year existence.
Banks use a base rate, which is usually the cost of funding plus a margin and a risk premium, to determine how much they should charge a particular customer.
The cap, which set interest rates for all customers at four percentage points above central bank benchmark lending, had taken out that equation and the flexibility lenders say they must accommodate customers deemed risky borrowers.
The inability to price risk in lending is shutting out many potential borrowers as banks seek to de-risk already large defaults from the Covid-19 pandemic.
The 2006 Banking Regulations require banks to obtain the nod of the CBK when changing characteristics of products, including loans.
“Any change in product functionality changes the previously approved product, and therefore the modified product with fewer, more or otherwise different functionality must be approved by the CBK prior to launch,” the CBK reminded banks in a 2016 circular.
The CBK has repeatedly warned banks against returning to penalty rates higher than 20 percent in the post-rate cap regime and wants every lender to justify the margins they plug into their formula.