EXPERT COMMENT

We need new interest rate pricing model

In Summary

• Borrowers with poor credit scores are swiftly rejected while those with positive outlook are subjected to standard rates.

• Rising interest rates is partly what prompted a change in law over two years ago to cap loan charges at four percentage points above the benchmark Central Bank Rate.

A client counts money after withdrawing from a bank.
A client counts money after withdrawing from a bank.
Image: FILE

Borrowers in Kenya are either exploited by banks or rejected. Exorbitant interest rates are applied especially on digital loans where both formal and informal lenders thrive.

Borrowers with poor credit scores are swiftly rejected while those with positive outlook are subjected to standard rates.

The need for a new pricing system for interest rates, be it risk-based or not, is becoming increasingly clear.

 
 
 
 

Rising interest rates is partly what prompted a change in law over two years ago to cap loan charges at four percentage points above the benchmark Central Bank Rate.

By looking at a customer’s credit score and other risk factors, banks can start having meaningful conversations about a customer’s financial needs and what can be done to meet those needs in a sustainable way.

Credit data comprises of a consumer’s repayment patterns. The data is considered negative if the consumer doesn’t honour their commitments to repay premiums on time. Positive data on the other hand, reflects repayments made on time.

Before 2014, credit data held by credit bureaus were mostly negative hence the misunderstanding of blacklisting. That has since changed.  Today, sharing of positive data benefits the lenders and consumers alike, enabling more informed lending decisions and tailored pricing.

In risk-based pricing, lenders price their products according to their customers risk profiles. Customers that present a lower risk might get better interest rates.

This becomes a sign of an evolving credit market that is becoming more sophisticated and competitive.

An essential part of any loan application process will have the credit score on a credit report showing the consumer’s personal information, credit listings including repayment data and performance information and any inquiries made against them.

For banks, a consumer credit score gives a clearer view of the risk associated with bringing the customer on board. This allows them to target the right profiles and a chance to differentiate themselves in the eyes of their customers while also improving their own bottom line.

For consumers, the report helps them manage their credit and plan their financial future, as they have a better idea of what to expect when applying for loans. Applicants with a good credit profile get low interest.

Unfortunately, many borrowers don’t know how to find their credit reports. This presents an opportunity for lenders to educate customers on personal credit information and maintain their credit profile, something that should benefit them way beyond the current loan application.

The TransUnion chief executive officer spoke to the Star