Once upon a time, there lived a pig. Everyone told the pig how ugly it was. The pig went on a diet and lost ten kilos, but everyone still saw it for what it was: a pig. It hired the sharpest professionals to undertake reams and reams of research and spin scientific sounding data about how it was the best animal alive, but everyone still saw it for what it was: a pig. It finally walked into a shop and bought lipstick, which it promptly smeared on its pouty lips. But everyone could only see what it was: a pig. And so the pig lived unhappily ever after.
I have been writing this weekly opinion piece since March 2009, which would make it slightly over five years of a punishing weekly process of about 5 hours of staring into space wishing for a topic to emerge out of thin air followed by 3-4 hours of pounding furiously at my laptop to produce 1000 sensible words. I refrain from putting my credentials at the end of these opinion pieces simply because I don’t think one or two sentences can cover my (short) lifetime of experiences. But I feel for the sake of some readers, I should explain my background. Before I started writing I was, believe it or not, a real life banker. In the ten or so years that I worked in the industry I played various roles but ended up as an executive director of not one but two banks. In the course of those roles I had direct responsibility over what we called the P&L and the Balance Sheet, meaning that I led teams that grew revenue (and, therefore, profit or loss) from the skillful management of assets and liabilities (on the balance sheet).
Pricing of those assets (or loans in regular-speak) and liabilities (deposits) was determined by myself but with the strong guidance of the Assets and Liabilities Committee or ALCO which committee is a regulatory requirement for any financial institution licensed by the Central Bank of Kenya. One of the core objectives for ALCO in any bank is to set the bank base rate as this is what will guide the pricing of all retail and corporate loans. The ALCO also gives guidance on what pricing on deposits should be based on the current cost of money in the market. I have therefore made pricing decisions on loans and on deposits. I undertook this role with my sleeves rolled up and heels tucked neatly under my table as I made money for my employer. On the corporate side we had bespoke pricing for the multinational and top tier local corporates, which meant that each client had their own unique pricing based on their historical, current and projected financial performance, quality of securities and past borrowing history. On the retail side, perhaps only the high net worth individuals would have differentiated pricing again based on their projected cash flows and quality of securities. The rest of the “watus” were managed in bulk for many reasons, one of them being primarily the cost of assessing past borrowing history, monitoring and differentiating individual credits would be herculean.
Not that it can’t be done, it’s just too much administration in a market that is not used to differentiation on a retail mass-market basis. And thus an unholy alliance formed within the banking sector for the retail mass-market customer segment. If the big Tier 1 banks that were the price-setters were not willing to differentiate on price, then the Tier 2 and Tier 3 banks would happily play in the same space, after all, it was more money for everyone. Furthermore, the large spreads being enjoyed above base rate in the retail mass-market allowed for historical operating inefficiencies to be catered for. However, there are banks that have managed to streamline their operations through automation and centralization but continue to ride the high interest rate gravy train. It’s too good to get off!
Why have I quibbled so much about bank pricing, which I already hemmed and hawed about three weeks ago? This is because my sentiments on the new Kenya Banks Reference Rate (KBRR), which come from actual practice rather than theoretical posturing about macroeconomic gobbledygook, have received some criticism as being the rambling justifications of an armchair analyst. I have warmed many armchairs, I most certainly admit, but they are the armchairs of retirement from active employment in a thriving and exciting banking industry.
So I say it again: John, who has borrowed 7 times in the last ten years and has faithfully repaid all his loans on time should borrow at say KBRR +2% whereas Julius who is a first time borrower should borrow at say KBRR +6% and Mary who has borrowed 5 times but defaulted on at least one of the loans should borrow at say KBRR +8%. The different margins reflect the credit risk for the perceived class of credit rating that each borrower represents and can easily be inputted into a credit scoring model. In theory, the KBRR should reflect, amongst others, the operating, funding, capital and market risk costs. In practice however, not all banks have the same costs in all the named parameters and it is therefore difficult to avoid loading other costs into the lending margin above which banks price their loans.
Banks are like any other enterprise that uses shareholder’s capital to generate profit. They also have every right to set their own pricing for their products and can differentiate and thereby reduce the pricing of loans for individuals if they want. It just needs one brave bank to do that. Just like an insurance customer sees a lowered premium year on year as a “no claims bonus”, the retail mass market customer John, who borrows regularly and repays faithfully, should desire for his cost of borrowing to come down. John is not interested in his bank’s Base Rate versus KBRR. That’s just lipstick on a pig.