CONSUMER FINANCING IN KENYA
SBP Financial Stability Report 2007- 08:
Consumer finance is an established financial product across the globe, particularly in mature economies, where it constitutes a significant portion of banks’ lending portfolios
•In the Kenya banking sector, however, the evolution of the consumer financing portfolio is a more recent phenomenon, as banks have traditionally focused on lending to the corporate sector and public sector entities
•While two prominent foreign banks took the lead in introducing credit cards in the banking sector in the mid ‘90s, their outreach was limited to the top tier of salaried customers and businessmen
•Emulating the experience of various foreign banks who had a head start in this area, domestic private banks have exhibited remarkable adeptness in adopting new procedures for credit risk assessment, setting up the requisite policy and collections units, and upgrading the scope of their IT based systems
•In doing so, they successfully introduced several innovative products for the individual consumer segment
•On the demand side, the consumer, who previously did not have access to bank credit without sufficient liquid collateral, responded well to these initiatives?
Factors responsible for the widespread popularity of consumer finance in recent years:
•The financial liberalization process over the last decade or so, has led to the creation of a banking system which is largely owned and operated by the private sector, and is free to allocate resources in response to the demands of a market based mechanism,
•Secondly, the influx of liquidity in the banking sector since FY02 motivated banks to diversify and expand their earnings base by venturing into previously untapped areas,
•Thirdly, the easy monetary policy stance of the central bank from FY02 to FY05 provided eligible customers with financing options at historically low rates to meet their consumption demand. In this backdrop, consumer finance has emerged as one of the most promising asset products for banks
•Providing access to purchasing power to the middle class consumer has been the most significant achievement of this product class
•Not only have people been able to raise their standard of living by purchasing various consumption goods which were previously treated as luxuries in reach of only a few, demand for these goods has also led the manufacturing sector to expand its capacity, such that both backward and forward linkages have contributed to the expansion in economic activities
•Hence, in promoting their consumer financing products, banks have played their due role in promoting economic development in the country
Consumer Banking
Warning Signals:
Abuse in Credit Cards Usage
A FOOD FOR THOUGHT The Nature of Modern Finance
Is modern finance more like electricity or junk food?
This is, of course, the big question of the day.
If most of finance as currently organized is a form of electricity, then we obviously cannot run our globalized economy without it. We may worry about adverse consequences and potential network disruptions from operating this technology, but this is the cost of living in the modern world.
On the other hand, there is growing evidence that the vast majority of what happens in and around modern financial markets is much more like junk food – little nutritional value, bad for your health, and a hardhabit to kick.
The issue is not finance per se, i.e., the process of intermediation between savings and investment. This we obviously need to some degree.
But do we need a financial sector that now accounts 7 or 8 percent of GDP?
CONSUMER FINANCE IN KENYA:
Some Myths and Facts
•Access to, and growth in, consumer finance carries both social and economic significance for the society
•In the absence of such products from the formal banking sector, people used to borrow from money lenders in the informal sector at exorbitantly high interest rates
•Banks have now facilitated them in acquiring the necessities of life by providing credit against their future incomes and cash flows, at rates far lower than those demanded by players in the informal sector
•Since the consumer finance function in itself is quite labor intensive, demand for this product has led the banking sector to employ a significant segment of the active workforce both on full time and part time basis
•Banks themselves have also benefited from the diversification of their credit portfolio, as well as capital savings under the Basel II regime, and consumer finance has brought higher returns and stability in earnings
The phenomenal growth in consumer finance has also raised a debate regarding its downside risks and implications.
It is generally perceived that this particular asset product has:
- Given rise to consumerism in Pakistan, this has contributed to the low level of national savings;
- Fueled inflation; and
- Led to the rise in speculative activities in asset markets
An analysis of actual facts and figures, however, dispels these notions
•Consumer Finance has certainly met the individual consumer’s needs for personal expenditures, but in doing so, it has also generated demand for consumer durables and other goods and services which have in turn translated into a chain of economic activities
•For the consumer, monthly payments for servicing the loan are a form of forced savings
•Rather than promoting consumerism, this product has contributed in enhancing the standard of living of the middle class, which is the back bone of any economy
•Moreover, trends in savings of the household sector also do not support the perception of consumerism, as the average saving rate of the household sector is higher in the post 2000 period as compared with the ’90s
•An analysis of inflation dynamics does not support the claim that consumer finance is the reason for the build up of inflationary pressures in the economy
•Core inflation, which is more sensitive to the level of credit and associated increase in demand, has shown quite contained growth over the last few years (Figure 5.5)
•The recent rise in overall inflation is attributable to factors such as international price shocks, and anomalies in administrative and fiscal policies
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Personal loan is the only product which is not tied to a specific purpose, and thus could potentially be utilized for speculative transactions in asset markets.
However, its potential for spurring speculative activities is limited because of the fact that:
(a)given its unsecured nature, this loan is priced competitively and is not an attractive funding option for speculators;
(b)its main target market is mainly the fixed income / salaried segment of individual customers who are generally risk averse and are not known to indulge in speculative activities;
(c)such loans are relatively smaller in amount (average loan size Ksh. 20,000) than other categories of consumer finance, whereas speculative transactions in asset markets generally require larger sums of money;
(d)the level and annual growth of this particular portfolio is quite small in comparison with other possible contributory factors such as the liquidity generated by increased foreign remittances and reverse capital flight, as well as the easy interest rate regime that prevailed up until a few years back, where disbursed loans for even small corporate entities and businesses could potentially have been miss-utilized
•Essentially, consumer finance, if utilized judiciously and within prudent limits, is a handy tool for propelling economic growth, ensuring smooth consumption patterns and improving credit risk diversification
Consumer Banking
•That said, indiscriminate growth in this asset class in an unstable macroeconomic environment, without a corresponding strengthening of risk management systems, could potentially create systemic lnerabilities (Recall Bank Business & Operating Model)
Because the financial system is so integrated — financial institutions borrow and lend large sums with each other every day in normal times—problems in a few banks can create a systemic risk for the financial system as a whole.
Paul O’Neill, a former Treasury secretary under President Bush, summarized this risk with a nice analogy: “If you have ten bottles of water and one is poisoned, but you don’t know which, no one drinks water”.
CONSUMER FINANCING IN KENYA ISSUES, CHALLENGES AND WAY FORWARD
STUDY REPORT Published by
Consumer Rights Commission of Kenya
Kenya Consumer Banking Landscape Issues/Concerns from Consumers Perspective:
1 .High Interest Rate Spread
2 .Variable Interest Rate
3 .Increasing Inflationary Impact
4 .Deteriorating Quality of Services
5 .Unsolicited Financing
6 .Lack of Consumer Education
7 .Poor Information Disclosure Practices
8 .Loosing Competitiveness in International Trade
9 .Intimidating Recovery Practices
10Weaknesses. in Regulatory Framework
1. High Interest Rate Spread:
Low interest rate spread is an important indicator of the efficiency and competition in the financial systems and helps in economic growth through increased investments. In the national context, the most important issue in consumer financing from the standpoint of national economy as well as individual consumers is that Kenya has one of the highest interest rate spread in the world.
An analysis of the interest rate behavior in Kenya reveals that the spread has vacillated between 5.95% and 9.58% during the period from 1990 to 2005. This indicates that average deposit rates have been very low, as compared to average lending rates. One could have expected a decrease in spread as a potential gain of competition among the increasing number of banks in the post-2001 period. However, little change has been observed in average spread, which points towards a cartel-like behavior of the banking sector.
If we look at the nominal and real interest rates, it becomes evident that consumers have had suffered a great deal at the hands of banks. From 1990 to 2004, the nominal weighted average lending rate has always been higher than inflation rate. The real lending rates averaged between 1.98% and 9.69%, which means that the banks earned net profits on lending in all these years. In contrast, the average deposit rate was slightly higher than inflation rate in four years only (1999-2002). The real deposit rates were negative in 11 years. It partly explains the impact of inflation on interest rate spread. The banks keep the lending rate high enough to ensure that the real lending rate is almost always positive.
In recent years, the spread has exceeded 7% on the average. The high difference between lending and deposit rates indicates that the depositors are not getting due returns, as compared to huge profits being earned by the banks. Indeed, the lending rates have increased and deposit rates have decreased over the last few years.
In February 2008, the weighted average lending rate was 11.23% whereas the weighted average deposit rate was 4.17% resulting in high interest rate spread to the tone of 7.04%. In terms of average interest rate spread of banks in South Asia, Kenya has the highest spread. From 2003 to 2005, its average spread has remained between 6.33% and 7.79%. Whereas, during the same period, it ranged between 4.50% and 6.9% in India, 4.34% and 5.99% in Sri Lanka, and between 5.27% and 6.11% in Bangladesh (Table 4).
While the spread is higher in South Asian as compared to other regions, Kenya stands out distinctively due to huge difference between lending rate and rate of return on deposits. The spread in Kenya is much higher than average rates in many countries around the world. Chart 2 shows average interest rate spread in 13 countries, which ranges between minimum 1.71% (Japan) and maximum 4.5% (Italy). This is evident
from these statistics that average interest rate spread in Kenya exceeds the regional as well as international average rates.
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High interest rate spread indicates that competitiveness in the banking sector in Kenya is either absent or is very poor. A cartel -like behavior in banks appears to have taken place within the policy space provided by SBP. In April 2006, the present Governor of the SBP had said that banking spread was very high in the county and termed it an inefficiency of banks. In December 2006, she said that spreads were high because the sector was not facing competition and it was hurting the economy. However, she said that time was yet to come when SBP should exercise its powers.
This issue is largely attributable to weak SBP regulation of interest rates despite that it has the powers to bring down the spread through monetary policy. While non-operating loans and high administrative costscould be considered as the major reasons in countries where spread is high. These reasons cannot be said true of Kenya because banks are earning huge profits at the cost of savings of the depositors.
2. Variable Interest Rate:
A variable interest rate moves up and down based on factors including changes in the rate paid on bank certificates of deposit or treasury bills. From a consumer’s standpoint, it makes a huge difference whether the bank is charging variable or fixed rate on credit. If a consumer enters into an agreement with the bank on the basis of fixed interest rate, the bank cannot change the overall payable interest during the entire tenure even if interest rates go up in the market. In contrast, when the interest rate is variable, the bank ties the rate with an index. The interest payable by the consumer varies as the index changes.
In Kenya, almost all consumer loans are on the basis of variable mark up rates. This policy is attributed to two reasons. First, variable rates are in the larger interest of banks due to high probabilities of increase in rates in the future. Second, a long term debt market has yet to be developed to provide term funding to the banks. However, banks also offer loans in which borrowers are given the choice of fixed or variable mark up. If the borrower chooses fixed mark up, the rate offered is generally higher than the variable mark up rate at the time of the contract. Therefore, borrowers most often choose variable mark up, without realizing their future financial liability, in the hope that the rates will fall in the future. This has seriously affected the loan servicing capacity of the borrowers with deleterious effects on their savings.
Some countries have determined fixed or variable interest rate for each sector depending on specific needs. In the United States, for example, the interest rates on education loans were changed from variable rates to fixed rates in 2002. In addition, there are examples of discount periods for variable interest rates. Such practices need to be introduced and scaled up in Kenya in order to serve the interests of small borrowers.
- Increasing Inflationary Impact:
•Easy bank credit by the household consumers has spurred the demand for many essential and luxury items
•Ultimately, the increase in demand has not only escalated the prices of essential items, but has also stimulated hoarding and black-marketing thus multiplying the problems for poor consumers. (Un-intended Consequences)
•Similarly, the demand for road networks and fuel imports has increased due to growth in auto financing
•These developments have an overall inflation impact, which is affecting the purchasing capacities of the poor
- Deteriorating Quality of Services:
As the consumer financing portfolio is increasing, quality of related banking services is becoming a serious issue. Processing delays, service inefficiencies, unauthorized debits and non-compliance with requirement of providing monthly bank statements are few examples of poor quality of banking services. Other issues such as non-transparent advertisements, violation of agreed terms and conditions, levy of unjustifiable charges, and arduous complaint redress mechanism, etc. also reflect upon the poor quality of consumer services.
The press frequently reports such complaints, which speak of the issues in quality of banking services. For example, some banks are involved in charging late payments penalties despite payment on time. Similarly, many credit card users complain about service charges appearing on their credit statements, which make no sense to anybody. The number of complaints is increasing every year. For example, in the first eight months of the operation of Banking Ombudsman in 2005, about 40 per cent complaints filed with the Ombudsman were related to consumer products, and among these complaints, 30 per cent were related to credit cards alone.
In 2006, Banking Ombudsman received 215 complaints out of which 18 were rejected, 71 were declined and 90 complaints were granted. There were 36 complaints related to internal banking fraud scam, still being investigated by the Banking Ombudsman. The complaints received at Banking Ombudsman were related to service rules, service inefficiency, and loan remission of mark-up waiver, frauds and consumer products. However, it is observed that percentage of complaints received regarding consumer products was 46%, much higher than other type of complaints received.
The complaints related to consumer products included credit cards, small loans, auto loans, undertake mark up, processing delays and ATM’s complaints. Magnitude of credit card complaints was much more than all other complaints, nearly 40% of total complaints.
- Unsolicited Financing:
•Aggressive marketing campaigns launched by the banks are targeting the consumers and repeatedly encouraging them to purchase a loan or credit card