Borrowers are bracing for increased interest rates on loans as banks receive key regulatory approvals from the Central Bank of Kenya (CBK) to start charging customers based on their risk profile.
Banks say the risk-based pricing regime will allow them to lend to riskier borrowers who were initially locked out in the period of interest rate cap that ended in November 2019.
But the risk-based pricing model, while accommodating all customers based on their chances of defaulting, looks set to raise the cost of credit past the current 13 per cent.
Early indications show that the best rate in the market for good borrowers will be at about 13 per cent while the upper limit will be as high as 20 per cent, raising fears that pre-rate cap levels could return.
Lenders argue that they have to balance accessibility, affordability and profitability and that will mean an increased rate for customers deemed riskier.
CBK has had to send back several banks to rework their models to avoid high rates.
Equity Group recently received the regulator's nod to start charging interest rates of between 13 per cent and 18.5 per cent, meaning that it will now move from the current flat rate.
“We now have no excuse of leaving anybody behind because we can price risk within a reasonable range,” said Equity Group Chief Executive Mr James Mwangi.
Equity’s weighted average effective interest rate stood at 9.88 per cent in 2020 compared to 10.34 per cent the previous year, and the CBK approval means it will now raise its price of loans.
CBK data showed weighted average interest rates were at 19.65 per cent in 2012 but slowed to 13.67 per cent in 2017—the first full year of rate cap—and further to 12.44 per cent in 2019.
The latest data puts the indicative interest rate at 12.12 per cent in January 2022, being lower than the lower limit that Equity has set.
While demand for credit has gone up in the personal and household, trade and manufacturing segments, growth of lending to the private sector has been largely muted.
Many lenders have in the last two years been negotiating with CBK over the pricing of their loans.
The interest rate cap regime had set maximum prices at four per cent above the CBK benchmark rate, making loans to average 13 per cent but also locking out millions of borrowers from accessing loans.
KCB Group, which is awaiting CBK approval, is also looking at having a range with 13 per cent being the base, according to CEO Mr Joshua Oigara.
“We expect to get final approval this or next week. There is latent demand for this model, which has been a work in progress for 24 months,” he said.
He said the banking sector has not been able to price risks correctly in the absence of risk-based pricing formula.
Mr Oigara, whose term at KCB was renewed recently, expects the prices to rise for those deemed riskier but says the rates may not hit the highs that were in the market before the 2016-19 rate cap regime.
“After the end of the regime of interest rate cap, we were not able to price the risk for those clients for 2020 and 2021. We have customers today who are being priced at prime rates,” said the KCB boss.
“We are not able to price today prime plus one so the discussion with the regulator is to bring in more risk buckets so that we have additional risk premium.”
Eyes will now be on lenders, especially on the upper limit they will set given the pre-rate cap outcry regarding the high cost of credit. The spotlight will also be on the level of charges such as loan insurance and negotiation fees that has also seen the overall charges on loans go up.
Many lenders had cut lending to the private sector as they shunned those individuals with credit risk above the capped rate, leading to the scrapping of this regime.
Private sector credit growth was, for instance, growing at above 20 per cent between November 2013 and September 2015 but fell below 10 per cent by June 2016 when the rate cap came in.
The figure averaged 7.75 per cent last year from 8.07 per cent in 20220 as lenders continued their preference for government paper —Treasury bills and bonds.
CBK data shows banks’ loan accounts dipped by 1.35 million between 2017 and 2019 on the back of interest rate cap laws.
This means that thousands of prospective borrowers were unable to access fresh loans from banks even as most maturing loans were paid.
Only 15.37 per cent of the total 46.55 million bank accounts at end of 2017 had taken loans, which was a drop from 18.9 per cent in 2016 and the peak of 24.6 per cent in 2015.
In 2019 alone, personal or household loan accounts, which accounted for over 85 per cent of loan accounts, dropped by 519,000, showing the struggles of borrowers to access credit.
A credit survey report conducted by the CBK in December showed 77 per cent of banks had seen improved liquidity.
However, when asked where they want to deploy the additional funds, only 28 per cent of the lenders said they will target the private sector compared to 43 per cent that will focus on government paper and 17 per cent that will use it for the interbank market.
Credit to rise
Mr Oigara said credit to the private sector will start rising again as banks get room to price borrowers who had been locked out.
“My expectation from the sector is that credit will grow because of risk-pricing coming in the market," he said.
"What I have seen is the misunderstanding that increasing the pricing will make it difficult for the customer to borrow. Actually, it will bring in more clients."
The amendment to the Banking Act was signed into law in August 2016, sparking a long fightback from lenders who argued they were unable to price risk in their customer loans.
KCB, Standard Chartered Bank of Kenya, Stanbic and Absa have all said they are also at the tail end of discussions with the CBK, signalling that all banks could soon migrate to the risk-based pricing model.
“Credit growth will always be determined by the level of demand. We lend to the real economy," said Standard Chartered Bank of Kenya CEO Mr Kariuki Ngari.
"I believe that risk-based pricing widens the net, which means there are people who currently have no access to credit that will start getting it.”
The banking sector's financial performance data for the past five years shows that the lenders have recovered their footing after the initial hit from the rate cap, largely by turning to risk-free government lending and aggressively cutting costs.
Now the era of risk-based pricing promises to give lenders tailwinds to grow their profits further, having weathered Covid-19 storms.
Banks’ pretax profits for the full year ended December 2021 grew by 72.7 per cent to a record Sh194.8 billion, taking the earnings past the pre-pandemic levels.
Lenders have in a space of six years faced three major disruptions—change of accounting standard, interest rate cap and now Covid-19 pandemic, but came out sparkling like gold from fire.
Major lenders such as Equity, KCB and Co-operative Bank of Kenya were also able to tap into long-term loans to boost their muscles for lending to small and medium-sized enterprises.
Global funds such as the International Finance Corporation, European Investment Bank and French development agency AFD have lent money to local banks for this course.