President William Ruto has been a proponent of single-digit lending rates.
He reiterated the same call in a recent tripartite event that was attended by Safaricom, KCB, and NCBA. However, this is not the first time he has advocated for loan rates to be in the single digits. He ordered the National Treasury to look into measures to increase Kenya’s private sector credit and mortgage finance penetration in 2013, when he was the Deputy President. A Cost of Credit Committee was established as a result, under the direction of the Treasury.
A new loan pricing mechanism known as Kenya Banks’ Reference Rate plus a “K” (or KBRR+K) was created as part of the committee’s recommendations and went into effect in July 2014.
The KBRR was calculated as the weighted two-month moving average of the 91-day Treasury bill rates and the Central Bank Rate (CBR), and it was to be reviewed and made public by the Central Bank of Kenya (CBK) every six months through announcements from the Monetary Policy Committee (MPC).
The “K” was a premium that was to be added to the reference rate and was based on a number of variables, including the financing expenses, non-funding costs, and risk profile of the borrower.
As a result, the central bank fixed the KBRR at 9.13 percent for six months during the July 2014 MPC meeting, and any loans that were priced outside of the formula had a year to be repriced within the guidelines.
However, there was a reason for this push. Bank lending rates in Kenya have been a contentious topic for a long time. There has been a widespread belief that banks act like cartels (by charging exorbitant rates).
In Kenya, there had previously been two unsuccessful attempts to regulate loan pricing.
The first was the well-known Joe Donde Bill, which was vetoed by the president on January 1 of that year.
The 2012 Finance Bill, which tried to control lending rates by enacting caps, was the second. The Bill was brought to Parliament, where the majority of the members voted against it.
In both of these two unsuccessful initiatives, a ceiling on lending rates and a floor on deposit rates were both sought after.
The KBRR structure was designed to promote transparency rather than control loan prices. Commercial banks use a Base Rate to determine the pricing of their loans; the Base Rate’s calculation varies between banks. Additionally, by serving as the only industry-wide reference base rate, KBRR was intended to standardize Base Rate determination in addition to increasing pricing transparency.
For a few reasons, the price framework did not have much success. First, because the loan market is institutionally driven, a sizable portion of borrowers are large or mid-sized companies that benefit from some form of discount.
This basically suggested that the pricing formula only applied to just under half of the outstanding credit facilities, a fact that did not have the necessary psychological impact to cause the market to correct lower.
Second, unlike many of its counterparts in Sub-Saharan Africa (SSA), Kenya’s economy continues to be influenced more by exchange rates than by interest rates. Finally, the failure was partly due to a lack of policy alignment between the monetary and fiscal policies. The KBRR+K formula ultimately had to be dropped when interest rate caps were implemented in late September 2016.
However, the President’s reinvigorated effort now focuses on credit referencing and contributes to the larger discussion of risk pricing. Simply said, credit rating and referencing are tools for pricing, not a death sentence. Perhaps how commercial banks use the referencing is the issue rather than credit reference bureaus themselves. Banks seem to only be interested in Boolean referencing at the present, which only determines whether a borrower is good or bad (ignoring or leaving behind a much richer and exhaustive set of data about a borrower).
In general, scores reflect a borrower’s behavior based on past borrowing and payback.
The cost increases with riskier behavior. Whatever the case, the future may not see the 20 percent or more lending rates that were once the norm.