Descriptive

1. Cost of Credit
HOW RISK-BASED PRICING(RBP) AFFECTS THE COST OF BORROWING
MERCY N NEHEMA

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HOW RISK-BASED PRICING(RBP) AFFECTS THE COST OF BORROWING
How Risk-Based Pricing affects Your Loan.The Central Bank of Kenya (CBK)
has been pushing for a risk-based pricing framework to be adopted by the banking
sector. As a result, commercial banks can now factor in a borrower's creditworthiness
when applying for a new loan, loan top-ups, and during loan restructures.As of October
this year, at least 22 of the 38 commercial banks have cleared their risk-based
management models by the regulator.Central banks seek to have a uniform approach to
Fees and commissions charged during loan processing to standardize the cost of
obtaining credit for individual and business loans; this move has faced backlash from
the banking sector as this will hurt their profitability.Risk-based pricing occurs when
lenders offer different categories of borrowers, differential interest rates, and other loan
terms based on their estimated risk portfolios.Loan pricing on Annual Rate-APRFor
personal secured loans, the average Annual Percentage Rate (APR) for the top 5 most
expensive banks is 19.1%, with the average annual interest rate coming in at 14.5%.
For personal unsecured loans, the average APR for the five most expensive banks is
24.8%, with the average annual interest rate coming in at 13.8%. For mortgages, the
average APR for the tier 1banks is 28.0%, with the average annual interest rate at
14.3%.On average, the annual interest rate for tier 1 banks is 13.8% - 14.5% for the
various categories of loans offered. This is approximately 7.0% points higher than South
Africa's average annual rate, which stands at 7.5% and 11.2% higher than USA's 3.3%.
However, Kenya's average annual interest rate is 6.5% lower than Ghana's average
lending rate of 21.0%.According to CBK, the private sector credit growth declined in
2021, coming in at an average of 7.8%, compared to the 8.0% recorded in 2020, partly

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due to the cautious lending strategy adopted by banks during the COVID-19 operating
environment.The most common options include mobile money, banks, informal groups,
insurance, digital apps, and microfinance institutions. According to the 2021 Fin Access
Report, mobile money was the most used financial platform accounting for 81.4% of
users, followed by banking institutions at 44.1%, then informal groups at 28.7%.
However, the usage of digital loan apps declined to 2.1% in 2021, from 8.3% in 2019,
mainly due to increased competition from bank-based product innovations and non-
listing borrowers to the Credit Reference Bureaus (CRBs).The impact of the CRB freeze
on current Lending.The directive by CBK to freeze default status for loans for one year
led commercial Banks to heavily cut back on Lending to individuals and small
businesses whose risk profiles and creditworthiness could not be determined.Risk-
based pricing allows lenders to set prices according to risk exposure. If a borrower is
considered risky, the risk-based pricing framework will have them pay higher interest
rate t rates, fees, and commissions, resulting in a higher total cost of credit.Lenders look
at a variety of factors when evaluating risk. Of course, your credit history is an integral
part of any risk-based pricing decision.Lenders may look at many additional elements,
such as loan-to-value (LTV) ratios, debt-to-income ratios, and other factors related to a
borrower's overall financial picture and current obligations. These will affect the ability to
pay back the loan in case of default.On the other hand, risk-based pricing gives people
an opportunity they otherwise would not have had. Instead of being denied, they're told,
"you can borrow, but it'll cost· you. "If everybody knows how the system works, it seems
fair enough. Regulators want to ensure borrowers understand when they pay more
under risk-based pricing, so they now require lenders to notify borrowers who pay

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higher prices.It's important to note that Risk-Based Pricing must be based on objective
measures such as credit score, income, and employment and not on prohibited bases
like age, race, and religion. A borrower should be presented with the Risk-Based Pricing
notice if it were based on their credit score, which helps you understand what the
perceived risk is and how it's affecting pricing. The borrower would be under no
obligation to accept the loan terms if they disagree with the offer.