Absa takes on small lenders with cheap personal loan offer

By VICTOR JUMA
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Summary

• An Absa customer taking out a one-year unsecured personal loan of one million shillings today will incur a total cost of credit of 71,807 shillings.
• Absa’s main rivals, including DTB and Equity Bank, are fixing a similar loan of 95,807 shillings at 114,057 shillings.
• Almost all banks have an interest rate of 13% or slightly lower, with the divergence in the total cost of credit being mainly based on differences in other discretionary charges.

Absa Bank Kenya #ticker: ABSA has joined smaller lenders in offering the cheapest personal loans, breaking ranks with other big banks that have continued to issue relatively expensive credit facilities.

An Absa customer taking out a one-year unsecured personal loan of one million shillings today will incur a total cost of credit of 71,807 shillings.

This is the same as the funding costs one will face at First Community Bank (FCB) and Housing Finance (HF) for a credit facility of a similar size and term. Bank of Baroda is the cheapest at Sh70,794.

Absa’s main rivals, including DTB and Equity Bank #ticker:EQTY, meanwhile are pricing a similar loan of Sh95,807 at Sh114,057. Absa was previously among the most expensive lenders.

Almost all banks have an interest rate of 13% or slightly lower, with the divergence in the total cost of credit being mainly based on differences in other discretionary charges.

Loan pricing estimates are taken from the Cost of Credit website developed by the Kenya Bankers Association (KBA) which aims to improve transparency in the formal credit market.

The KBA says the estimates are a starting point for a potential borrower interested in taking out a loan, adding that contacting a bank directly will give the official price of the loan.

Absa’s charge of 71,807 shillings for the one-year unsecured one-million-shilling personal loan represents pure interest payments at a rate of 13% over the life of the loan.

The credit facility is repaid monthly, with interest charged on a declining balance.

Equity Bank also charges 13% interest or 71,807 shillings, but has a higher total cost of credit of 114,057 shillings for a similar credit facility. This is due to an additional fee of Sh42,250 including loan application fee.

The KBA says banks can also collect fees for other parties, including lawyers, insurers and the Kenya Revenue Authority.

However, interest-only banks do not collect internal or third-party fees.

Other major banks with higher total cost of credit due to internal and external charges include DTB and I&M Bank #ticker:IMH, which will charge 95,807 shillings and 100,160 shillings respectively for a similar credit facility.

NCBA #ticker: NCBA will charge a total of Sh104,807, KCB #ticker:KCB (Sh107,207), Co-op Bank #ticker:COOP (Sh111,929) and Standard Chartered Bank Kenya #ticker:SCBK (Sh112,745 ).

Pricing trends show that most major banks are pricing their loans at roughly the same level, indicating minimal competition.

Their huge lending capacity also means that they are indifferent to the cheaper credit terms offered by smaller institutions.

Assuming more customers flock to the small, cheap banks, they won’t get the loans they need. Bank of Baroda, which currently offers the cheapest loans, had issued loans of 51.9 billion shillings in September 2021.

Equity Bank Kenya, meanwhile, lent 367.5 million shillings over the same period, with the big banks generally dominating in terms of lending capacity and other measures including the number of customers.

Customers have been found to show high levels of loyalty to their banks, indicating that a majority are not looking for better deals and are more interested in just accessing loans.

The latest KBA customer satisfaction survey shows that almost eight out of 10 respondents said they would recommend their banking service providers to others.

“Finally, customers were asked if they would recommend their respective banks to other customers. This question sought to assess the level of customer satisfaction with the services of a bank,” the association explains in the survey published last week.

“It also reflects a customer’s willingness to recommend the services of said bank to those closest to them – friends and family. Based on the results, it was established that almost eight out of 10 respondents (77.6%) answered in the affirmative, indicating their willingness to recommend their service providers to others.

For most banks, the fees they add to interest charges are one way to protect their margins as the industry continues to experience a de facto lending rate control regime.

Interest rate caps were removed on November 7, 2019, after three years, allowing banks to increase the cost of loans for customers who are at higher risk of default.

But the Central Bank of Kenya (CBK) has intervened administratively, forcing lenders to submit new loan pricing formulas that will guide their interest rate changes.

To date, most banks have not received approval for their risk-based loan proposals, even after multiple discussions with the regulator.

Part of the discussions involves an explanation of the factors that drive loan pricing such as cost of funds, return on assets, operating costs and risk premium.

The CBK, which in 2019 warned banks against returning to punitive interest rates of more than 20% under the rate cap regime, wants each lender to justify the margins they put in their formulas.

The regulator appears to be concerned that borrowing rates will reach high levels ahead of the years of rate caps that were the catalyst for the introduction of interest rate controls.

During the freewheeling years, most banks charged interest rates above 15% and the most aggressive approached 30%.

The impasse seen in the proposed risk-based lending system left the average lending rate in the industry stuck at an average of 12.16% in December, according to CBK statistics.

This is lower than the rate available on certain public debt securities, which present no credit risk, unlike households and companies which can default in one out of 10 cases.

The latest infrastructure bond, for example, has a fixed interest rate of 12.96% and has been oversubscribed by banks and other investors.

However, adding charges to interest or ordinary loans allows banks to match or exceed the yields of medium- and long-term government debt securities.

A one-year unsecured personal loan of 1 million shillings at an interest rate of 13% plus fees of 42,250 shillings results in a total cost of credit of 114,057 shillings or an annual percentage rate of charge (APR) of 21%.

This means that shorter term loans are more profitable for banks due to the possibility of charging fees each time a customer takes out a new credit facility.

For long-term loans, fees appear only once and therefore reduce the frequency of fee recycling.

Most retail customer loans, including those offered through mobile banking platforms, have terms of one to three months, and some extend up to one year.

There is no cap on the fees that lenders attach to loans, allowing institutions to vary them according to their needs to increase their margins or win more customers.

The KBA says the annual percentage rate, determined by discretionary fees, is the most relevant metric for comparing loan costs.

“There are various costs associated with a loan. These costs are in addition to the interest rate component and range from bank fees and charges to third party costs, such as legal fees, insurance and government levies,” the association said.

“Since loan seekers will tend to focus only on the interest rate when making a lending decision, banks have proactively adopted the Annual Percentage Rate or APR model which converts all costs costs associated with the loan (also known as the total cost of credit) into a number.”

With the APR, borrowers are able to comprehensively compare different loan products on a comparable basis, based on the total cost of the facility and therefore make better informed credit decisions, KBA added.

Small banks, which are generally the cheapest, use their advantageous loan pricing as one of their main competitive advantages in winning customers, since they lack the advantages of large banks, including a large customer base, a network wider distribution and a larger marketing budget.

While Absa is a large bank financially, its customer base is closer to that of smaller institutions than large lenders and its decision to offer cheaper loans could be a strategy to increase its market share.

Absa had 250,000 loan accounts in December 2020 while those of Bank of Baroda, FCB and HF stood at less than 12,000 each according to the latest CBK banking supervision report.

NCBA Bank Kenya had the largest number of loan accounts with 7.3 million, although the majority of these were microcredit accounts offered through its mobile banking services.

KCB was second with 1.8 million loan accounts and was followed by Co-op Bank (800,000), Equity (700,000).

For retail customers, the ease of access to loans is valued more than the cost of credit facilities. This is evidenced by the growing popularity of alternative lenders, including mobile and digital platforms, who charge much more exorbitant interest rates on their short-term loans.

Some of the platforms are charging annualized interest rates of over 300%, with players saying they need a higher risk premium because the loans are unsecured and have higher default rates.

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