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Why banks are seeking overhaul of loan pricing models
The Central Bank of Kenya (CBK) Governor Dr Kamau Thugge when he appeared before the Committee on Finance and National Planning at Continental House Nairobi on March 14, 2024
Commercial banks are in talks with Central Bank of Kenya (CBK) for an overhaul of their loan pricing models to come up with a common base lending rate amid concerns that they are not cutting interest rates in line with reducing central bank rate (CBR).
The lenders have sent proposals to CBK Governor Kamau Thugge, arguing that the current models are sticky and have made it difficult for them to adjust rates downwards as soon as the regulator gives the cue.
The planned overhaul of the models comes two and half years after the industry got approvals to start applying these models after switching from the interest rate cap regime.
1. How did banks end up with the current risk-based pricing models
Banks came up with the risk-based pricing models after the banking sector regulations were changed to phase out the regime where interest rates were capped at a maximum of four percent above the CBR and a minimum deposit rate floor at 70 percent of the CBR.
The rate cap regime lasted between April 2016 and November 2019 before it was phased out allowing banks to develop their own models which they submitted to the CBK for approval.
2. What is the issue with the current risk-based pricing models?
While the risk-based models allowed banks the flexibility to charge customers rates based on risk profile and add in their margin, it has proved to be difficult for lenders to quickly adjust the pricing of loans when CBR changes.
Thugge has held several meetings with banks to understand the misalignment between CBR and lending rates.
He has even threatened to fine those that do not adjust rates. However, lenders have insisted that their pricing is in line with the models which the CBK approved after a lengthy period of back and forth.
“The bottleneck is that the pricing model we have today is not sensitive enough to the market changes. We need a market observable benchmark to drive the model for pricing,” according to Stanbic Bank Kenya and South Sudan CEO Joshua Oigara.
3. What are banks proposing in their push for a review?
Banks are still consulting under their umbrella body, Kenya Bankers Association (KBA). They are seeking a single reference rate for the sector.
A reference rate would mirror the Kenya Banks’ Reference Rate (KBRR) that was discontinued in 2016 when the interest rate cap regime set in.
KBRR was introduced in July 2014 following discussions between financial institutions and banks as a way of ensuring that banks are transparent with respect to the cost and pricing of their products. The framework required banks to disclose and explain to their customers the effective base rate and any additional premium.
Absa Bank Kenya CEO Abdi Mohamed says the focus now is to find a more transparent and standardised base rate with an improved transmission of CBR.
Mr Oigara says the uniform reference rate will be more like the secured overnight financing rate (SOFR)-based model for foreign currency loans. “It is time to reopen the components and think about the reference rate,” he said.
Banks want a model that offers a blend of cost of funds such as the treasury bills and CBR that can reflect a more current price than relying on 12-month averages.
What are the concerns of the CBK?
CBK is concerned that banks are not cutting interest rates as fast as possible despite successive CBR reductions. The regulator wants banks to cut lending rates in order to stimulate the flow of credit to the private sector.
The private sector credit growth posted a 1.4 percent contraction in December 2024, marking an occurrence last seen in 2002.
Why does overhauling the risk-pricing models matter for customers?
Risk pricing models determine the interest rates charged to customers when they tap loans. An overhaul is therefore expected to have an impact on how loans will be priced and how quickly the interest rates will be changing when certain changes occur in the market such as adjustments in the CBR.
How were banks reacting when CBR was rising?
Many banks were perceived as too quick in revising upwards their lending rates when CBR was rising. They were using the same models that they argue are not transmitting CBR changes as fast as customers would want.
However, banks dispute this position, arguing that their interest rate margins were always behind the curve—an indication of the lag effect.
How soon can the revisions on the pricing models happen?
Banks are still in discussion with the regulator. Many say they expect feedback by May but this could drag, going by the long wait it took for them to get their current pricing models approved.
