Tough times for banks as new rules on interest rates take effect
Kiva executive board chairperson Julie Hanna. PHOTO | JOSHUA MASINDE | NATION MEDIA GROUP
What you need to know:
New rules led to fall in credit cost in Peru, Ghana, and SA
The new formula may force the more than 40 banks in Kenya to compete more on pricing, as it compels banks to reveal the true cost of borrowing to a customer.
Studies show that detailing the annual percentage rate (APR) has the potential to reduce interest rates that customers pay on loans by fostering price competition among lenders.
This has been proven in countries such as Peru in South America. In Peru, for example, the switch to APR resulted in a 15 per cent fall in interest rates.
In Ghana, the central bank reviews and publishes rates from lenders quarterly in newspapers.
Elements that the consumer can verify personally, such as processing fees and insurance premiums, are not included.
Financial institutions in Peru provide complete information regarding interest rates, commissions, and other fees through leaflets, posters inside banks, staff, and sponsored websites.
APR was also found to be the most common disclosure regime in the developed world and was supported by extensive regulation on the definition of interest rate, its calculation, accuracy, scope, and dissemination.
South African-based advisory firm, Genesis Analytics, was commissioned by the Central Bank of Kenya and Financial Sector Deepening (FSD) Kenya on this issue.
The standard pricing approach was recommended in a bid to promote greater transparency and consumer protection within the local financial sector and to allow consumers to compare rates and shop around.
Currently, it is difficult for the average consumer to understand the overall cost of credit or benefits attached to savings products because the interest rate is presented in different terms — simple, compound, variable, or fixed — with other charges and fees hidden.
Genesis Analytics based its recommendation for a uniform disclosure regime on experiences in the US, UK, Ghana, Ireland, Malaysia, Canada, Peru, and South Africa.
The Central Bank, as the regulator, is expected to guide and enforce compliance and disclosure, especially on standardisation and calculation of charges, for the APR to be effective.
The latest biannual monetary policy report released by CBK in January showed that the large banks charge borrowers up to 2.45 percentage points more compared with smaller banks.
It said the big banks take advantage of their expansive branch network and brand recognition to price their loans higher than their smaller competitors and pay the lowest interest to those who save with them.
Small banks had the lowest average spread — difference between interest charged on loans and interest earned on deposits — at 9.55 per cent, followed by medium sized banks at 9.57 per cent, and large banks at 12 per cent.
Commercial banks are struggling to fit into a new interest rate computation regime that requires them to give customers a rate capturing the total cost of borrowing.
The big issues the banks are grappling with include third party costs which, though part of the credit acquisition process, the lenders have little or no control over, yet they affect the pricing.
Under the new rules, banks are required to give borrowers a rate that is reflective of all the costs paid to acquire a loan, detailing items such as fees paid to lawyers and valuers and insurance premiums.
These rules came into effect on 1 July, when banks were required to compute the annual percentage rate (APR).
“The costs have to be computed, yet as an industry we cannot directly control them. These are among the greatest challenges to full implementation of APR,” said Kenya Bankers Association boss Habil Olaka.
LENDERS ON HIGH ALERT
APR is meant to standardise the cost of borrowing, helping borrowers to make an informed decision on where to get credit. It is hoped that this will increase competition and eventually bring down the cost of lending.
Some banks are, however, said to be adding a disclaimer to the letter of offer, stating that their rates exclude third party costs.
Under the new rules, lenders are required to clearly state the APR to allow a customer to make an informed decision on whether to take a loan or not.
By failing to input third party costs, banks could effectively be misrepresenting the true position of the loan advanced.
This, according to legal experts, could open banks to litigation, especially under the new consumer protection law.
It is this dilemma that has lenders on high alert and comes on the back of ongoing litigation where a consumer wants banks ordered to refund charges levied between 1989 and 2006.
According to Ms Rose Florence Wanjiru, the charges levied were illegal because they were not approved by the Minister of Finance, in line with Section 44 of the Banking Act, which states: “No institution shall increase its rate of banking or other charges except with the prior approval of the minister.”
DISADVANTAGE CUSTOMERS
Banks are said to have ignored this critical section. The fear is that this could be repeated in regard to exclusion of third party fees.
On paper, the model ushers in a new phase of transparency in the costing of products by lenders. However, bankers have expressed reservations about third party costs on loans pricing.
APR is a measure that shows the complete and true pricing of loans. It takes into account the set interest rates and other third party charges vital in calculating the borrowing rate such as legal and valuation fees, insurance costs, and government levies.
Commercial banks in Kenya have been in the spotlight over claims of hidden costs that disadvantage consumers.
The Competition Authority in March started investigating banks over the pricing of their products to establish the extent of competition in the sector following concerns about interest rate spreads — the difference between interest charged on loans and interest earned on deposits.
The 2013 bank supervision survey report released by the Central Bank of Kenya (CBK) shows that commercial banks made a combined profit-before-tax of Sh125 billion, almost double the 2010 profit of Sh74.3 billion and over 20 times what they made in 2002 profits.
REPAYMENT SCHEDULE
In 2002, the industry’s profit hit Sh6 billion, which more than doubled to Sh14.1 billion after the Kibaki administration came to power. The profit performance cemented the sector’s position as the most profitable in Kenya amid accusations of immoral interest rates.
Banks use an interest rate model that has been widely criticised for not containing full disclosure of certain transaction costs.
“In many instances, credit providers simply state the interest rate at which the credit is to be provided. There is no detail offered with respect to other charges that are levied on the consumer,” a report by Kenya Financial Sector Deepening says.
Banks are also accused of levying a flat rate, which when quoted appears to be lower than other interest rates.
“However, the flat rate is actually the most expensive rate that a credit product can be quoted on as the interest payments during the term of the product remain constant and do not take cognisance of the reduction in the balance owed.”
The annual percentage rate thus seeks to allow borrowers to compare lending rates among rival banks. This may increase competition in the banking sector.
Traditionally, CBK has required banks to provide loan applicants with a breakdown of the total cost of credit that includes bank charges and third-party costs as well as repayment schedule.
Under the new model, however, banks will disclose the total costs associated with the loan, the loan repayment schedule, and the APR mechanism.
REMAIN EXPENSIVE
The mechanism takes into account the interest rate component, bank charges and fees, and third party costs including legal fees, insurance costs, valuation fees, and government levies.
The mechanism was proposed in 2011 when interest rates in the country were at an all-time high of 25 per cent. Analysts are of the view that the annual percentage rate mechanism is what the Kenyan economy needs to address issues of consumer protection.
“It is a proactive move forward for our market to ensure more transparency and is in line with the Consumer Protection Act, which requires that consumers be aware of the cost of the products and services they buy,” said Mr Johnson Nderi, the corporate finance and advisory manager of ABC Capital.
Mr Nderi, however, says the new rule may not necessarily make access to credit easier because base funding is supplied by capital markets, which, taking into account the general market conditions, will remain expensive.
The implementation of the APR mechanism coincides with that of another model developed by a team appointed by Treasury.
From this month, all lenders are to subscribe to the new formula called Kenya banks reference rate (KBBR), further cutting the opportunities for banks to add hidden charges on loans.
All new flexible loans issued after 1 July, 2014, will be priced using the new KBBR framework, while a transition period of one year from 1 July, 2014 will be provided to allow banks to recalculate existing loans in line with the new framework and inform borrowers.
The KBRR will be based on the averages of the monetary policy rate and the 91-day Treasury bill yield over
