Rebalancing Kenya’s banks risk premium and profitability

Kenyan banks continue to grapple with non-performing loans (NPLs) that stand at 17.6 percent of their loan books as of June 2025, while loan-loss provisions have risen 12.4 percent year-on-year in the first quarter of 2025.

Yet, in that same quarter, banks reported pre-tax profits totaling Sh73.5 billion and posted average returns on equity exceeding 23 percent. Capital adequacy ratios of 20.1 percent and liquidity buffers of 58.4 percent further attest to the sector’s robust financial health.

Under the Risk-Based Credit Pricing Model, banks build their lending rate around the CBR plus a spread—often referred to as “K” to cover operational costs, expected shareholder returns, and a credit-risk premium.

With provisions swelling in response to bad debts, one would expect margins to tighten. Instead, profitability metrics far outpace global peers, where well-capitalised lenders typically target return on equity in the 8–15 percent range.

This gap raises a critical question: how much of the current risk premium truly reflects the cost of risk, and how much simply bolsters bank profitability? Addressing this imbalance demands a multi-pronged approach.

First, banks must publish a transparent breakdown of their lending spreads, clearly distinguishing between the cost of funds, the risk premium for bad loans, and the profit margin.

Second, the Central Bank should introduce a consultative approval process for the “K” component, ensuring that spreads are grounded in empirical data rather than discretionary benchmarks.

Third, deepening competition through an active interbank market and secondary lending platforms can help drive down banks’ cost of funds and anchor lending rates to competitivebenchmarks.

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Beyond transparency and competition, policymakers should incentivise banks to extend affordable credit to priority sectors.

Reduced reserve requirements or targeted tax incentives for loans to micro, small, and medium enterprises alongside an expanded public-private credit guarantee scheme, would undercut perceived risks and allow banks to offer lower spreads without compromising balance sheet resilience.

The CBK’s latest rate cut demonstrates a clear policy intent, to broaden access to credit and catalyse growth.

Kenyan banks are right to guard against credit risk, but their exceptional profitability signals room to recalibrate the trade-off between risk coverage and borrower affordability.

By aligning regulatory oversight, enhancing market discipline, and deploying smart incentives, we can ensure that the benefits of the CBR cut translate into meaningful rate reductions for households and businesses alike.

A time has come for the government to have a sit down with the banking sector on the sustainability of their profit and to what extent they can cut down on the NPLs if they absorbed abit of the risk factor-K factor for the good of the nation and to spur the private sector.

This trade off would in the long run be beneficial to the banks as it will not only spur the economy but also propel growth in the sector.

For scholars this is a rich area of research on the relationship between banks reducing their risk premium and to what extent it can lead to reduction in NPLs in the country.

The writer is a council member of ICPAK and a Certified Public Accountant, Certified Secretary and a Certified Governance Auditor. The views here are personal and do not reflect the views of ICPAK.