Risk-based lending could choke borrowers - Deloitte

The warning by Deloitte tax experts marries an earlier one issued by the International Monetary Fund

In Summary
  • In the approach, lenders are expected to link loan prices directly to the borrowers’ risk profile and past credit behaviour.
  • Most opponents to the model in the Kenyan banking industry say that risk-based pricing will complicate their existing credit programs
Deloitte offices in Westlands.
Deloitte offices in Westlands.
Image: FILE

Tax experts warn that Kenya risks choking credit supply to certain segments of borrowers if it adopts risk-based lending.

Under this approach, lenders are expected to link loan pricing to the borrowers’ risk profile and past credit behaviour.

According to Charles Luo, Leader, Deloitte Financial Institutions Services Team, the approach will give wealthy customers easy access to low-cost loans while less well-off borrowers may not be able to bear the costs of borrowing, denying them credit.

The tax consultancy firm in a report on banking trends notes that most opponents to the approach in the industry said that risk-based lending would complicate their existing credit programs.

They also raised concerns that the approach would result in disgruntled customers.

“Issues may arise when a credit analyst denies a customer a lower rate and there is difficulty in explaining the reasons behind the credit decision,” the bankers said.

The report notes that others are opposed to the approach due to potential legal implications that it poses around discrimination in issuance to the different customers.

“Others have also raised the issue that risk-based lending complicates their existing credit programs and may also result in disgruntled customers,” the report notes.

Deloitte however says that the approach, as for any new model will come with challenges but the positive implications for both lenders and borrowers are too powerful to ignore.

For instance, the firm says the approach will allow banks to optimise revenues from lending, and reward deserving, financially disciplined customers.

To prepare for a successful shift, Luo advises institutions to build their data capabilities and pull together systems to build a better view of customers.

This, he said, would position them well to capitalise on the opportunity.

The Kenya Bankers Association (KBA) and Central Bank of Kenya (CBK) have been fronting risk-based pricing of loans since 2019.

The industry is still in talks before moving forward with the adoption of the model.

At present, banks have continued to impose the 4 per cent interest rate based on the Centra Bank of Kenya rate.

Equity Group CEO James Mwangi said the lender is close to switching to pricing loans based on the risk profile of customers.

 Mwangi said that the discussions with CBK are close to conclusion and the switch to risk-based lending will allow it to accommodate riskier customers.

KCB Group Chief Finance Officer Lawrence Kimathi in a recent interview said the delay in the implementation of risk-based pricing was likely a factor of Covid-19 disruptions.

The warning by Deloitte reflects a similar position taken an earlier by the International Monetary Fund (IMF).

In a study on the effects of interest controls, with Kenya as a case study published in May 2019, IMF opposed the risk-based pricing model, saying it will fuel exploitation. 

“It is hard to regulate this kind of loan pricing model, ” IMF said.