Expensive loans on the horizon as banks seek CBK approval to hike interest rates

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Borrowers are bracing for higher interest rates on loans as banks receive key regulatory approvals from the Central Bank of Kenya (CBK) to charge customers based on their risk profile.

Banks say the risk-based pricing system will allow them to lend to riskier borrowers who were initially locked out in the November 2019 interest rate cap.

But the risk-based pricing model, which considers all customers based on their probability of default, is likely to raise borrowing costs beyond the current 13 percent.

Early indications are that the best interest rate in the market for good borrowers will be around 13 percent, while the cap will be as high as 20 percent, raising fears that pre-interest rate caps could return.

Lenders argue they need to balance accessibility, affordability and profitability, and that means a higher rate of interest for customers who are perceived as riskier.

CBK had to send several banks back to revise their models to avoid high interest rates.

Equity Group recently received the regulator’s commitment to charge interest rates between 13 percent and 18.5 percent, meaning it will now deviate from the current flat rate.

“We now have no excuse to leave anyone behind because we can assess risk within a reasonable range,” said James Mwangi, Equity Group’s chief executive.

The weighted average effective interest rate on equity was 9.88 percent in 2020 compared to 10.34 percent in the previous year, and the CBK’s approval means that it will now increase its loan prices.

CBK data showed that weighted average interest rates were 19.65 percent in 2012 but slowed to 13.67 percent in 2017 – the first full year of the interest rate cap – and 12.44 percent in 2019.

The latest data puts the indicative interest rate at 12.12 percent in January 2022, below the floor set by Equity.

While demand for credit has increased in the retail and household, trade and manufacturing segments, growth in credit to the private sector has been largely subdued.

Many lenders have negotiated the prices of their loans with CBK over the past two years.

The interest rate cap regime had capped prices at four percent above the CBK benchmark rate, allowing credit to average 13 percent but also preventing millions of borrowers from accessing credit.

Waiting for approval

The KCB Group, which is awaiting CBK approval, is also aiming for a range with 13 percent as a base, according to CEO Joshua Oigara.

“We expect to get final approval this week or next. There is latent demand for this model, which has been in the works for 24 months,” he said.

He said the banking sector has not been able to price risk correctly because there is no risk-based pricing formula.

Mr Oigara, whose tenure at KCB was recently extended, expects prices to rise for those seen as riskier but says interest rates may not reach the highs seen in the market before the 2016-19 rate cap regime.

“After the end of the interest rate cap regime, we were unable to price the risk for these clients for 2020 and 2021. Today we have customers who are priced at top interest rates,” said the KCB boss.

“We are unable to price Prime plus one today, so the discussion with the regulator is to introduce more risk baskets so that we have an additional risk premium.”

Eyes will now be on lenders, particularly the cap they will set amid the pre-cap outcry over the high cost of borrowing. Attention will also be paid to the level of fees such as credit insurance and negotiation fees, which have also led to an increase in overall loan fees.

Many lenders had cut back lending to the private sector as they shunned those with credit risk above the capped interest rate, leading to the abolition of this regime.

For example, private sector credit growth grew by over 20 percent between November 2013 and September 2015, but fell below 10 percent by June 2016, when the interest rate cap was introduced.

The figure has averaged 7.75 percent over the past year, up from 8.07 percent in 20220, as lenders continued their preference for government securities – Treasury bills and bonds.

CBK data shows banks’ loan accounts fell by 1.35 million between 2017 and 2019 due to interest rate cap laws.

This means that thousands of potential borrowers have not been able to access new loans from banks, even though most of the loans due have been repaid.

Only 15.37 percent of the 46.55 million total bank accounts had borrowed at the end of 2017, down from 18.9 percent in 2016 and a peak of 24.6 percent in 2015.

In 2019 alone, individual or household credit accounts, which accounted for over 85 percent of credit accounts, declined by 519,000, showing borrowers’ difficulty in accessing credit.

A credit survey report conducted by the CBK in December showed that 77 percent of banks reported improved liquidity.

However, when asked where they plan to use the additional funds, only 28 percent of lenders said they will target the private sector, compared with 43 percent who will focus on government bonds and 17 percent who will target the private sector interbank market will use .

credit to increase

Mr Oigara said credit to the private sector will rise again as banks are given leeway to price borrowers who have been locked out.

“My expectation from the industry is that lending will grow as risk assessment comes into the market,” he said.

“What I saw is the misconception that raising prices would make it harder for customers to borrow. In fact, this will bring in more customers.”

The amendment to the Banking Act was enacted in August 2016 and sparked a long struggle from lenders who argued they were unable to price risk into their customer loans.

KCB, Standard Chartered Bank of Kenya, Stanbic and Absa have all said they are also at the end of talks with the CBK, signaling that all banks could soon switch to the risk-based pricing model.

“Credit growth is always determined by the level of demand. We lend to the real economy,” said Kariuki Ngari, CEO of Standard Chartered Bank of Kenya.

“I think risk-based pricing is expanding the web, which means there are people who don’t currently have access to credit who are going to start getting it.”

Financial performance of the banking sector over the past five years shows that lenders have regained their footing after the initial hit from the interest rate cap, mainly by turning to risk-free government lending and cutting costs aggressively.

Now, the era of risk-based pricing promises to give lenders a tailwind to keep growing their profits after weathering the storms of Covid-19.

Banks’ pre-tax profits for the full year ending December 2021 rose 72.7 percent to a record Sh194.8 billion, pushing profits above pre-pandemic levels.

Lenders have seen three major disruptions in a six-year period – change in accounting standard, interest rate cap and now the Covid-19 pandemic – but they glittered like gold on fire.

Big lenders like Equity, KCB and the Co-operative Bank of Kenya have also been able to take out long-term loans to flex their muscles for lending to small and medium-sized businesses.

Global funds such as the International Finance Corporation, the European Investment Bank and the French development agency AFD have lent money to local banks for this course.

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