Commercial banks have rejected a proposal by the Central Bank of Kenya (CBK) to control lending rates, and instead want a free hand in determining the risk premium assigned to borrowers.
Through their industry lobby—the Kenya Bankers Association (KBA), the lenders claimed that the CBK’s proposal to review the risk charges on loans was tantamount to the reintroduction of interest rate caps.
The banks argue that all customers, including those with high credit risk levels such as low-income individuals and small businesses, will have access to credit if they get a free hand on loan pricing.
“CBK will review each bank’s proposed premium ‘K’ before rollout and determine both the base rate and the premium ‘K’ (interest rate capping). The proposed interest rate capping by CBK is not supported in law and would have the following effect,” said KBA in a statement on Thursday.
“Reduced lending to Kenyans and businesses, especially MSMEs as experienced between 2016 and 2019 when interest rate capping law was in place.”
Banks also note that they would not be able to honour their public commitment to support small businesses with loans of up to Sh150 billion annually starting in 2025.
The CBK has proposed the use of the Central Bank Rate (CBR) as the base for pricing loans, saying it captures the cost of funding for banks more than the interbank rate, which it says is more a reflection of the level of short-term liquidity in the market.
This CBK proposed regime will also have a premium added to the base rate determined by banks’ operating costs related to lending, return to shareholders, and the borrower’s risk premium. This premium will also need to be approved by the CBK before it is loaded onto loans.
The regulator further argues that the interbank rate is prone to volatility in periods of tight liquidity, and is also a backward-looking rate in contrast with the forward-looking CBR which also takes into account other economic indicators such as inflation, exchange rate, and global developments.
“CBR is announced, in most cases every two months, which gives banks sufficient time to effectively effect changes in their lending rates,” said the CBK.
According to the CBK, lending rates are to be determined by adding a premium, denoted as ‘K’ to the CBR which is to comprise the bank’s operating costs related to lending, return to shareholders, and borrowers’ risk premium.
Banks are expected to factor in a higher or lower premium where the cost of funding is more or less than the CBR. All banks are to submit their proposed premium to CBK for review before rolling out.
Commercial banks, however, argue that controlling the premium range would stand against free market rules.
“Flexibility on the premium ‘K’ is consistent with the law that recognizes a liberalised interest rate regime in Kenya.
Beyond the base rate, ‘K’ should be allowed to be fully flexible across banks, products, and clients based on each bank’s differentiated cost of funds, operational costs, shareholder’ expected return on investment, and customers’ risk premium,” said the KBA.
Banks have since 2019 applied the risk-based credit pricing model to determine lending rates which allows the pricing of loans according to the perceived risk of individual borrowers.
Despite CBK approving the risk-based credit pricing models for all banks last year, the apex bank noted that some banks failed to adhere to the framework resulting in good borrowers paying more for credit despite a lower risk profile.
CBK said that inspections of banks revealed that some were not implementing their risk-based pricing models as agreed.
“Some banks did not apply RBCPM model pricing to some credit facilities such as mobile loans, cash-backed facilities, facilities underfunded schemes, and facilities under the government-to-government arrangements,” KBA added.
“Some banks were imposing additional charges outside the RBCP model. The key changes imposed are late penalty interest rates, commitment fees, negotiating fees, and processing fees.”
Banks also want CBK to base the revised pricing model on the interbank rate and not the central bank rate (CBR) saying the latter charge is a global standard reflective of actual market-determined costs.
CBK differed with banks on the use of the interbank rate, citing volatility during periods of tight liquidity in the market and that not all banks participate in interbank lending.
