A realistic solution to the interest rate dilemma
The decision by the National Assembly to pass the Banking (Amendment) Bill, 2015 has triggered intense debate on the anticipated consequences of controlling the pricing of loans by commercial banks in Kenya. If approved by the President in the form presented to him, the new law will cap lending rates at four percent above the Central Bank Rate (CBR) and set minimum interest rate for deposits in interest-earning accounts at 70 percent of the CBR. The raging debate has generally pitted us into two opposing sides, one holding the populist view that Kenyans will henceforth enjoy access to cheaper credit, while the experts generally predict credit rationing and a flight to quality leading to the unintended freeze of access to credit for higher risk borrowers. Ultimately, it boils down to a debate over what is more valuable: cost or access?
In this debate, there is at least some aspects of consensus that we can celebrate. Both sides agree that something must finally be done to improve both the methodology and transparency of loan pricing in Kenya. There is also consensus that the data available in credit reference bureaus has not been applied as it should, namely to differentiate risk. Instead, it has almost exclusively been used to deny credit to persons with default history. This is a lost opportunity that lenders must turn away from very quickly.
This common ground provides us with the perfect opportunity to develop a consensus on how to resolve this dilemma. I hold the view that capping interest rates would constitute a mistake we will regret very soon. Lenders will quickly find a way to invest funds while avoiding lending to some crucial segments of the economy, such as the SMEs that are generally risker than most corporates, but which contribute greatly to our economic growth.
A mere rejection of the proposed legal amendments without instituting reforms would no doubt be another grave mistake. That would amount to entrenching the less-than innovative approach to financial intermediation we are currently witnessing. Too many lenders are applying one-sided use of credit bureau data without rewarding the good credit history that most consumers of credit have. They must also desist from submitting data to credit bureaus that is not verified, or that arises from mere lender generated bank-charges. Strict guidelines on ensuring data quality to CRBs would be one measure towards restoring credibility and effectiveness of credit information systems.
Capping of interest rates without sufficient room for recognizing diversity of risk is quite unrealistic. Lenders must instead focus on entrenching credit bureau scores in the determination of lending terms. Government could enforce this by demanding transparency in the application of credit scores. In the end, lenders would be expected to apply say, x% above CBR for credit scores of between 300 and 400 and y% above CBR for credit scores ranging from 400 to 500.
This proposal is not without challenges. One concern arises from the varying credit scoring methodologies applied by the three credit bureaus licensed to operate in Kenya. Transunion CRB, Metropol CRB and CreditInfo CRB have each developed different methodologies in the determination of credit scores. This can be addressed by establishing a standard scoring platform into which the scoring systems of different credit bureaus scales can be mapped. This will retain respect for intellectual property while allowing harmonization in the application of scores for lending and comparability of loan pricing.
Jared Getenga is the CEO CIS Kenya and a Credit risk Expert.