- We tend to focus on the loan interest rate when comparing bank products; however, the interest rate does not cover the full cost of the loan. This is why the Total Cost of Credit or TCC disclosure by banks is important.
- For further pricing transparency, banks have voluntarily adopted the Annual Percentage Rate or APR pricing model. APR is the numerical representation of the Total Cost of Credit.
- Because banks will use the same model to calculate the APR, borrowers are empowered to compare loan products on a like for like basis; and therefore make more informed decisions on all the components of the loan (interest rate plus all charges and third party costs).
- There are various costs associated with a loan. These costs range from bank fees and charges to third party costs, such as legal fees, insurance, and government levies.
- When taking up a loan, a borrower often focuses on the bank interest rate; however, this is just one of the loan cost components. Therefore, to better determine the total cost, a formula should be used to compute the various elements into a numeric representation (a percentage rate). When this percentage rate is based on a r a 12 month period, it is called the Annual Percentage Rate (APR).
- In most countries APR is mandated by law. But in Kenya, the banking industry has proactively adopted the APR model in conjunction with the Central Bank of Kenya’s requirement that banks provide customers with the Total Cost of Credit (TCC) and Loan Repayment Schedule.
- While the APR and TCC disclosures do not have directly and immediate effect on the cost of credit, customers will be empowered to shop around for the loan products that meet their needs.
- The enhanced transparency will therefore stimulate competition within the banking industry thus contributing to more competitive interest rates for customers with a good credit track record.
- When you borrow, the cost you incur is beyond the interest rate. Borrowers should therefore know about the “Total Cost of Credit” or TCC associated with the loan or credit facility.
- The TCC will include the bank interest rate based on the KBRR plus a premium that covers the Cost of Funds, the Margin and Risk. Third Party Costs directly associated with the loan are also covered in the TCC, these include legal fees, insurance, valuation, and government levies.
- Previously, banks used to price their loans using a Base Rate. The formula for calculating the Base Rate varied from bank to bank. Central Bank of Kenya has now prescribed a common Reference Rate known as the Kenya Banks Reference Rate or KBRR.
- KBRR factors in CBK's monetary policy direction (based on the Central Bank Rate) and the risk free rate in the market, which is the 91-Day Treasury Bill rate.
Banks are structured and operate differently. However, the loan Interest Rate charged by a bank is determined by 2 characteristics, namely bank-specific characteristics and customer-specific characteristics.
- Bank Specific Characteristics (Cost of Funds & Margins)
- Banks will price loans based on their Cost of Funds. This is a cost that is influenced by both wholesale deposits and deposits from individual bank customers (also known as retail deposits).
- The wholesale deposit rates significantly influence the loan interest rate. For example, corporations typically require a high interest rate to be paid for the deposit they keep with a bank; the bank therefore will price most of its loans based on that wholesale deposit, plus margin to cover the bank''s operational costs, risk and return to shareholders (profit margin).
- Customer Specific Characteristics (Risk Profile & Product Specifications)
- Just as banks are different, so are customers. When issuing a loan, banks will assess a customer based on that customer''s ability to repay the loan. This is called the "risk profile" of the customer. There is a price associated with the likelihood that the customer will repay the loan, or the likelihood of default.
- To determine the customer''s profile, a bank will use a Credit Report provided by a licenced Credit Reference Bureau. The Credit Report covers the customer''s Credit History (an account of debt obligations and repayment track record).
- There are also different product types. Depending on the product, there would be a cost associated with the risk the bank would take by selling the product. For example, an unsecured loan carries a higher risk than a loan secured by an asset (collateral).
- The banking industry in collaboration with Central Bank is spearheading a number of interventions to enhance credit access. These initiatives, which are at different stages of implementation, include: the Credit Information Sharing initiative which will enable banks to price their loan products based on individual customers’ risk profile; and development of a Reference Rate upon which banks will replace the Base Rate and serve as a standardized reference rate for all banks.
- Through the Committee on Increasing Private Sector Credit and Mortgage Finance Chaired by National Treasury, KBA has also proposed several other measures meant to address the inefficiencies that contribute to higher costs within the financial services industry, including reforms within the Ministry of Lands.
- It is important to note that the high interest rate regime is not permanent; once market stability is attained, rates trend downwards, as we have seen in the recent past. A good signal that the market is indeed responding to the decline in interest rates is the increased uptake in credit during 2013 and First Quarter 2014 (as reported by the Central Bank).
- The APR is only one of the factors that a prospective loan applicant can use to make a decision.
- Other factors are the additional value that the bank is providing including supplementary services and flexible repayment terms.
- Yes. Every bank customer can access the Total Cost of Credit template and APR calculator on the KBA website at www.kba.co.ke. The customer will still need to ascertain the accuracy of the costs from the bank so as to ensure that the self-computed APR is accurate. However, the APR calculator will provide a good indication of what to expect.
What do I do when I am not given this information by my bank or if am charged more than was initially in the APR?
- This information is the right of every bank customer. Customers should raise any issues with the relevant customer care representatives or the banks' head office. Customers can also email email@example.com and a Kenya Bankers Association member of staff will facilitate a response from the bank.