CBK Freezes Top Lenders’ Bid to Increase Borrowing Rates

In response to complaints from lenders, the Central Bank of Kenya (CBK) has halted major banks’ efforts to increase the cost of loans for borrowers with greater credit risks.

When the government stopped regulating loan costs, the regulator asked banks to submit new loan pricing formulas that would serve as the foundation for determining interest rates.

The CBK is yet to give the nod to six of the nine tier-1 banks — Co-operative Bank, NCBA, KCB, Diamond Trust Bank, Standard Chartered, and I&M Bank —nearly three years after lenders submitted their applications.

The six, who together make up more than half of all loans, believe that the CBK freeze has compelled them to continue conducting business as though lending rate regulations were still in effect.

Most borrowers have been protected from expensive lending by the regulatory freeze, particularly small business owners and employees in the unorganized sector.

The delay in the implementation of risk-based lending, according to banks, has compelled many of them to increase their investment in government securities and limit lending to high-quality clients who have reduced default risk.

24 of Kenya’s 39 banks have been given permission by the CBK to raise their lending rates in the past based on the risk profiles of the borrowers, however, the bulk of these permitted lenders are smaller institutions including Victoria Commercial Bank, Paramount Bank, Credit Bank, and the Middle East Bank.

Data from the Kenya Bankers Association (KBA), the industry lobby, shows that the only tier-one banks to receive the CBK nod are Equity Bank Kenya, Absa, and Stanbic Bank.

Loan costs for this group of borrowers can reach 21.02 percent compared to a base rate of 12.5 percent, with lending rates for high-risk groups rising by up to 8.5 percentage points.

The CBK has taken over as the de facto controller of the cost of credit, notwithstanding the banks’ eagerness to price loans to various clients based on their risk profiles.

Every time banks modify the terms of any product, including loans, they are required under the Banking (Increase of Rate of Banking and Other Charges) Regulations of 2006 to obtain CBK permission.

In November 2019, the government lifted the loan ceiling following three years of criticism that it had slowed the expansion of credit.

To decide how much to charge a specific customer, banks add a base rate—typically the cost of funds—plus a margin and a risk premium.

This calculation and the flexibility that lenders claim they need to accommodate consumers who are regarded to be risky borrowers were removed by the cap, which set rates at four percentage points higher than the central bank’s benchmark lending for all customers.

Many potential borrowers are being turned away because of the inability to price risk in lending as banks attempt to lower their exposure from already high default rates brought on by the Covid-19 outbreak.

The CBK has previously stated that there is no cause for concern over the approval delay of the risk models.

“This [the approval of banks for risk-based pricing] has been ongoing. This story was overblown in the past. We have been working with banks, going back and forth with them,” CBK Governor Patrick Njoroge said earlier.

“More than half of the banks have already had their risk-based models approved or signed off with us. For others, we are at different levels of completeness but again, we know what we need to insist on is making sure that the models are realistic and not just some sought of the class project. Issues that were raised before were somewhat overblown.”

Prior to the removal of lending rate limitations on November 7, 2019, some bank executives complained to the International Monetary Fund (IMF) about the CBK’s reluctance to approve lenders’ requests to increase the cost of loans.

According to the bankers’ lobby, risk-based pricing is mostly used for new loans, with credit demand and industries with default risks serving as the primary risk criteria.

“Most banks are implementing risk-based pricing on new and not old loans. [On the application of risk metrics] it depends on the assessment of the demand for credit on each segment and how the same loans are performing, which is weighed against the prevailing environment,” said KBA Head of Research Samuel Toriongo.

In the wake of the worst drought in forty years, he noted, credit facilities to industries like agriculture would currently fetch a higher risk premium.

The demand for risk-based lending to be used more widely comes as bank loan costs reached a 52-month high in December as a result of CBK rate increases and rising yields on government securities.

The average loan rate increased to 12.67 percent in December from 12.22 percent in May of last year, when the banking regulator lifted rates for the first time in nearly seven years, according to CBK data.