The new open pricing of private sector credit in Kenya has raised hopes of more affordable loans in future, but its impact could be stifled by excessive government borrowing and runaway banking costs.

Last Tuesday the Central Bank set the inaugural Kenya Bank Reference Rate (KBRR), a uniform base rate above which commercial banks are expected to compete for borrowers by adding the lowest premium.

“This transparency will be important in pulling down credit costs. It will enable borrowers to compare different lenders and choose what works for them,” said Interest Rate Advisory Centre chief executive officer Winfred Onano.

The KBRR was set at 9.13 per cent — the average of the Central Bank Rate and the 91-day Treasury bill rated averaged for the past two months — and took effect immediately. It will be reviewed every six months starting January 2015.

The Treasury Bill rate rose from a single digit level for most of May and June, to 11.4 per cent in the past two weeks.

“In the past, opacity has meant that while a bank may charge you lower rates, it recovers its money by charging you higher banking fees on such transactions such as overdraft, commitment fees and ledger fees. Having a single rate will make the comparison much simpler,” said Mr Onano.

Banks will be required to charge a variable above the KBRR, determined by their cost of deposits, overheads, borrower risks and mark-ups.

Lenders will then quote their flexible loan products at an annual percentage rate (APR), the sum of the reference rate and the variable christened K. It is expected that the rate for each bank will be regularly published to enable borrowers to make informed choices on where to borrow from.

“It will mostly help customers to shop for the most competitive rates in the market since the pricing mechanism will be standardised across banks. In the long term, competitive factors will set in with customers only going to banks with lower rates forcing the other banks to price their loans competitively,” said FSD Kenya head of future financial systems Victor Malu.

FSD Kenya is a World Bank-funded programme that champions financial inclusion.

Although the KBRR is not meant to lower borrowing rates, cheaper credit could be a long-term result, especially with an ongoing banking competition study expected to indicate whether prevailing interest rates are justified.

“People are saying the rates are high, but what is the threshold of ‘high’? It is only when the study findings are out that we will know this,” said Mr Malu.

Bankers say factors like economic performance, competition with the government for cash and internal efficiencies of specific banks will have a bearing on the effective lending rate even with KBRR and APR in force.

“An interest rate regime is not permanent; when market stability is attained, rates trend downwards, as we have seen in the recent past. When there is instability in the market, it will be the reverse despite some of the measures that will be in place,” said Kenya Bankers Association chief executive officer Habil Olaka.

The average deposit rate in Kenya is 6.42 per cent, against an average base lending rate of 16.97 per cent. This leaves a spread of 10.55 per cent, which the World Bank has in recent studies said discourages borrowing.

The Bank attributed more than half of the spread — 5.6 percentage points — to profit, overheads at 4.7 percentage points and the balance to provisions and reserves.

The KBRR will apply to loans offered on flexible interest rates, which constitute 90 per cent of the assets held by banks. However, about two-thirds of these advances are to large companies and SMEs, which borrow either at the base rate set by banks or below, and are offered competitive rates above the Treasury Bill rate when they place short term deposits with the banks.

This leaves KBRR as a factor for only a third of the market, the segment dominated by personal and consumer loans. With the T-bill rate a key factor in determination of KBRR, consumers of personal loans can only hope that government reduces its appetite for borrowing locally.

Government borrowing

The government has over the past two years breached its domestic borrowing target and plans to borrow Ksh190 billion ($2.2 billion) from the market this year. If there are indications that the target will be exceeded before January, the T-bill rates could drag the reference rate upwards in the next review, assuming the CBR remains where it is.

The new pricing regime, however, could force lenders to cut their dependence on interest income which accounts for about 80 per cent of their revenues.

“The likely effect is that banks will now start competing more on service provision and value addition for which they charge fees rather than relying wholly on interest income,” said Mr Olaka.

Banks are not under obligation to review existing facilities until July next year, and have a one month window to announce APR for new borrowers.

“There are several factors beyond the interest rate that a customer would take into consideration. In addition, banks tend to focus on their niche market for which the pricing may vary while still based on a common reference,” said Mr Olaka.