A recent proposal submitted to the Central Bank of Kenya (CBK) by the Kenya Bankers Association (KBA), which could fundamentally reevaluate credit pricing in one of Africa's most significant economies, may potentially result in changes to loan prices across the country.
Over the past years, the credit system in Kenya has suffered due to a lack of consistency and structure, stunting growth in confidence and competitiveness.
This permeating issue stems from each bank creating its own base rate, which causes other banks to follow suit in an attempt to remain relevant within the market.
This culminated in Kenya enduring the Cross Bank Overhead charging or CBK Overhead Interest Rate limits being lifted in 2019, without relieving suffocating loans for the general population.
Examining past blunders exposes the lack the Kenya Banking Reference Rate of 2014, upgraded in 2016 to a universal format, is of achieving its set goals, chiefly owing to variability in the equilibrium exchange rate market and the sporadic shifts in CBK's course on fiscal policy.
KBA's new strategy includes some innovative ideas, such as using the two-month average interbank rate to directly anchor rates to real market activity, instead of theoretical models, while also improving transparency via rate-sharing during Monetary Policy Committee meetings.
Additionally, the risk factor ("premium K") would encourage banks to compete based on their capacity to assess borrower risk instead of hiding the true base rate. Targeting new loans for disbursement over 12 months in duration focuses on the most impactful areas, while a six month trial period proves practicality.
Undoubtedly, the most noticeable benefit comes in the form of greater financing affordability, but other factors require greater focus.
For one, after three consecutive cuts to the key interest rate and a 0.75 percent reduction to the benchmark rate, bringing it down to 10 percent to stimulate business by lowering burdensome borrowing costs, the CBK has observed that these regulatory changes tend to not affect lending rates – which is a paradoxical outcome.
Within this proposed framework, the interventional relationship the CBK has with market outcomes may become clearer.
In addition, high capital costs, which have historically favoured large corporations with established banking connections, have hampered Kenya's development, while a clearer, more consistent system might facilitate fair loan access for smaller, emerging businesses.
Despite Kenya's economic growth, banking access is still hampered by costs, but this approach could extend credit to underserved communities without jeopardising bank stability by lowering loan costs while maintaining prudent risk assessments.
The strategy is not without risks, though, as interbank rates can fluctuate significantly during crises, which could cause instability in the credit market at a time when stability is most needed.
Banks could also get around the goals of the reform by simply shifting hidden fees from the base rate to the risk premium, and the focus on longer-term loans could split the credit market into two systems with different pricing strategies.
The success of this approach hinges on several critical adjustments, beginning with clarification of the plan's "premium K" risk component, which, without proper regulations, could allow banks to merely shift their hidden expenses from the base rate to the risk add-on; therefore, the CBK should mandate that banks disclose to consumers the specific factors influencing their risk assessment, including how debt ratios, credit ratings, and collateral values affect the final interest rate.
Even though the two-month average of interbank rates smooths out small fluctuations in the market, it is lacking during large market crises because there is no contingency plan to contain the collapse of the credit system during times of extreme market turmoil.
In addition, the approach has to correct the imbalance between short- and long-term loan markets by moving more incrementally toward all loans, which would help mitigate distorting effects and limit banks from redirecting their attention to the more lucrative segment.
Considering strategic adaptions to incorporate anticipated shifts in CBK policies would enhance the system, as the current approach relies on past interbank rates and incorporating some of them might improve the pricing structure to consider current conditions, expected market changes, and present conditions.
During the test period, unambiguous success indicators must be established, including interest rate changes, lending volume, approval rates for various borrower categories, and tangible economic outcomes, because without precise criteria for success, the evaluation of the test becomes subjectively interpreted.
The recent measures taken by the CBK seems to illustrate a possible willingness to entertain the banks' proposals. If this reform becomes a success story, then it could potentially be used as an example for other African countries that face similar challenges in their credit markets.
While moving through the test phases, officials need to strike that right balance between serving the broader economic objectives and the expectations of the banks, as the KBA plan does provide an opportunity to literally redesign credit circulation within the Kenyan economy, not just fix it technologically.
In fact, with the recommended and careful supervision, this plan could provide a resolution to what is referred to as 'the paradox of an advanced economy technologically structured financial system in Kenya" – why is it so difficult to obtain a loan and why is it always considered expensive? striking the desire to achieve economic goals.
The writer is a Development Economist, Public Policy Specialist and Management Consultant. Email: [email protected]
