A well-kept secret in Kenya’s banking industry is the method that lenders use to determine interest rates for small borrowers that they consider risky. But People Daily can reveal the method is at the heart of the banks’ spirited fight against Parliament’s move to cap the rates.
To lend to the risky customers, banks add additional interest, also called risk premium. This premium is the goose that lays the golden egg in the sector and is largely responsible for Sh101.3 billion the banks posted in profits last year. So how are these additional percentage points arrived at?
According to tabulation by Central Bank of Kenya in March last year on how much percentage points banks add on top of the base lending rate, which People Daily has seen, banks add different percentage points on different loan products. A base lending rate is an interest rate at which a bank can comfortably make profits without making additional charges.
Lending rate In March last year, the base rate also known as the Kenya Banks’ Reference Rate (KBRR) was 8.54 per cent while the average bank lending rate was 16.14 per cent. This sounds like a fair rate until you look at how the banks calculate interest rates for individual borrowers.
The tabulation by Central Bank reveals that small borrowers are the most severely punished for borrowing, with banks adding up to 26 per cent on top of the base lending rates. Interest Rates Advisory Centre managing consultant Wilfred Onono says most banks are worse than shylocks when it comes to small borrowers.
“When they say they do not want to send small businesses to shylocks, the banks are not being honest because they charge such businesses higher interests rates than the shylocks,” he says. Onono says the high interest rates have already sent thousands of businesses into the hands of shylocks.
“When you charge such high rates on small businesses, you force them into defaulting and then you list them with credit reference bureaus so that they cannot access formal credit. That is the fastest way to send small businesses into the hands of shylocks,” he says.
According to the rates collected by Central Bank, borrowers taking up microloans at Family Bank in March last year were charged a risk premium of 26.23 per cent on top of the 8.54 per cent base rate at the time. In other words, the borrower was charged a total interest rate of 34.77 per cent.
However, unsophisticated borrowers would not suspect they are charged interest rates that are higher than those offered by unlicensed shylocks since the rate for small borrowers is computed on monthly basis. Thus, in the case of Family Bank, a borrower would be asked to pay a monthly interest rate of 2.8 per cent on a microloan.
Banks also hit small businesses hard with some risk premiums going as high as more than 15 percentage points on the base rate. For instance, K-Rep Bank, now Sidian, charged an average risk premium of 15.87 per cent on small business loans.
This means that a small business borrowing from K-Rep was charged an interest rate of 24.41 per cent. The base lending rate was 8.54 per cent. On personal loans running for a term of between one and two years, banks added between 3.36-17.77 per cent.
In other words, loan interest of between 11.9 and 26.31 per cent. The bank that added the least points on the base rate was Bank of India at 3.36 per cent while Transnational added the most points at 17.77 per cent.
Save for K-Rep, which maintained a curiously high risk premium on corporate loans of 15.87 per cent, most banks charged very friendly risk premiums on loans to big businesses.
In fact, three lent to big businesses at an interest lower than the base lending rate of 8.54 per cent. NIC Bank lent to the big corporate at 1.54 per cent points below the base lending rate—meaning the big business loans attracted an average interest rate of seven per cent. Bank of India and Chase Bank cut off 0.92 and 0.63 per cent from corporate loans with a maturity period beyond five years.
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