Borrowers are bracing for higher 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 in during the interest rate cap period that ended in November 2019.

But the risk-based pricing model, while considering all customers based on their risk of default, looks set to raise the cost of credit beyond the current 13%.

Early indications show that the best market rate for good borrowers will be around 13%, while the upper limit will reach 20%, raising fears of a return to pre-rate ceiling levels.

Lenders say they need to strike a balance between accessibility, affordability and cost-effectiveness, which will result in higher rates for customers deemed riskier.

The CBK had to fire several banks to rework their models to avoid high rates.

Equity Group recently received regulator approval to start charging interest rates between 13% and 18.5%, meaning it will now move from the current flat rate.

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

Equity’s weighted average effective interest rate was 9.88% in 2020, up from 10.34% the previous year, and the CBK’s approval means it will now raise the price of its loans.

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

The latest data puts the indicative interest rate at 12.12% in January 2022, which is below the lower limit set by Equity.

While credit demand increased in the personal and household, trade and manufacturing segments, private sector loan growth was largely muted.

Over the past two years, many lenders have negotiated with the CBK on the pricing of their loans.

The interest rate cap scheme had set maximum prices at 4% above the CBK benchmark rate, providing loans at 13% on average, but also preventing millions of borrowers from accessing loans. loans.

Awaiting Approval

KCB Group, which is awaiting approval from CBK, is also planning to have a range with 13% as the base, according to CEO Mr Joshua Oigara.

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

He said the banking industry has been unable to properly price risk in the absence of a risk-based pricing formula.

Mr Oigara, whose term at KCB was renewed recently, expects prices to rise for those deemed riskier but says rates may not reach the highs that were in the market before the regime 2016-19 rate cap.

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

“We are not in a position to price today prime plus one, so the discussion with the regulator is to bring in more risk tranches so that we have an additional risk premium.”

Eyes will now be on lenders, particularly on the upper limit they will set given the outcry over the rate cap ahead of the high cost of credit. Emphasis will also be placed on the level of charges such as loan insurance and negotiation fees which have also seen overall charges on loans increase.

Many lenders had reduced their lending to the private sector as they avoided people with credit risk above the capped rate, which led to the abolition of this scheme.

Credit growth to the private sector was, for example, above 20% between November 2013 and September 2015, but fell below 10% in June 2016 when the rate cap came into effect.

The figure averaged 7.75% last year, down from 8.07% in 20220, as lenders continued to favor government paper — treasury bills and bonds.

CBK data shows that bank 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 been unable to access new loans from banks, even though most maturing loans have been repaid.

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

In 2019 alone, personal or household loan accounts, which accounted for more than 85% of loan accounts, fell by 519,000, showing borrowers’ difficulties in accessing credit.

A credit survey report carried out by the CBK in December showed that 77% of banks had seen their liquidity improve.

However, when asked where they wanted to deploy the additional funds, only 28% of lenders said they would target the private sector, compared to 43% who will focus on government securities and 17% who will use them for the market. interbank. .

Credit on the rise

Mr Oigara said credit to the private sector would begin to rise again as banks were given the opportunity to price borrowers who had been blocked.

“I expect the sector to increase credit due to the coming risk pricing in the market,” he said.

“What I have seen is the misunderstanding that the price increase will make it difficult for the customer to borrow. In fact, it will attract more customers.”

The banking law amendment was enacted in August 2016, triggering a long backlash from lenders who argued they were unable to assess the risk of their customer loans.

KCB, Standard Chartered Bank of Kenya, Stanbic and Absa all said they were also at the end of discussions with the CBK, signaling 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 CEO of Standard Chartered Bank of Kenya, Mr. Kariuki Ngari.

“I believe risk-based pricing widens the net, which means there are people who currently don’t have access to credit who will start getting it.”

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

Now, the era of risk-based pricing promises to give lenders tailwinds to further boost profits, having weathered the storms of Covid-19.

Banks’ pre-tax profits for the full year ended December 2021 rose 72.7% to a record 194.8 billion shillings, lifting profits above pre-pandemic levels.

Lenders have faced three major disruptions in the space of six years – changing accounting standards, capping interest rates and now the Covid-19 pandemic – but have emerged sparkling like gold from the fire.

Major lenders such as Equity, KCB and Co-operative Bank of Kenya have also been able to tap into long-term loans to build their capacity to lend to small and medium enterprises.

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.