How banks are denying good clients cheaper loans

Inspections were carried out ahead of a review of the current pricing model which is pegged on a base rate identified by a bank based on its administrative, deposits and operational costs, and target return on shareholders’ funds. The banks then load a risk premium based on a borrower's creditworthiness, collateral, and overall financial behaviour.

Having identified several shortcomings in the models and their implementation, the CBK is now proposing a new credit pricing plan with the Central Bank Rate (CBR) as the base for pricing all loans.

Lenders will then load a premium calculated on account of their operating costs related to lending, return to shareholders and a borrower’s risk premium.

“Some banks did not apply risk based model pricing to some credit facilities such as mobile loans, cash backed facilities, facilities under funded schemes and facilities under the Government-to Government arrangements,” said the CBK in the working paper.

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“Some banks were (also) imposing additional charges outside the risk based credit pricing model. The key charges imposed are late penalty interest rates, commitment fees, negotiating fees and processing fees.”

Other breaches include lending rate differentiation based on customer segments rather than the risk profile of individual clients, and failure to regularly update the variables used to determine the various components of their models.

Some banks were also found to lack adequate board oversight of their models after failing to document the model governance and review process in their credit policies.

On the cost of funds, those with a high concentration of term deposits recorded elevated cost of funds, leading to increased base lending rate.

There is also inefficient transmission of a cut in the CBR due to most banks using a six to 12-month average cost of deposits to compute their deposit cost, which determines their credit pricing as per the models.

The risk-based pricing model was rolled out in 2019 after the repeal of the interest rate cap law which had been in place since 2016.

The rate cap had caused a slowdown in lending to the private sector due to banks being unable to price in risk, with smaller lenders also finding it hard to mobilise deposits due to the inability to pay higher returns compared to larger banks that were perceived as less risky by depositors.

In choosing to go with the CBR as the new base for loan pricing, the CBK said that the rate reflects risk-free or near risk-free cost of funding to the banks, and it also takes into account a wide range of variables including inflation, global and local economic developments.

“CBR is announced, in most cases every two months, which gives banks sufficient time to effectively effect changes in their lending rates. It is also forward looking,” said the CBK.

Banks, through the Kenya Bankers Association (KBA), have on the other hand, proposed a unified base rate —the Kenya Base Rate (KBR)— anchored on the interbank rate.

They also want to add a premium determined solely by the banks without any reference to CBK, similar to the premium in the defunct Kenya Bankers Reference Rate (KBRR) regime that was succeeded by the 2016 rate cap.

The CBK says the interbank rate does not necessarily reflect cost of funding, but is instead a reflection of the level of short-term liquidity in the market.

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