The financial sector in Rwanda is about to experience an unprecedented wave of structural changes following Friday’s development of the country’s largest bank cutting down its lending rate.
Banque Populaire du Rwanda Plc (BPR) announced a reduction of its base lending rate from the current rate of 16.5% annually to 14.5% annually with effect from March 1, 2019.
The rate will be subject to change from time to time (downwards or upwards) depending on changes in money market conditions.
The Bank’s Managing Director, Maurice Toroitich, told journalists on Friday morning that the move is aimed at aligning its loan pricing policy to global best practice and to ensure that interest rates charged to customers are aligned to changes in money market conditions and risk profile of each loan amount granted.
The bank’s base rate is not the effective rate (actual rate) at which the bank will make credit available to its customers.
The base rate is instead the bottom rate which considers basic costs of making credit available to a customer regardless of the underlying credit risk.
These costs include the cost to the bank of the money which is lent to its customers, the operational cost of originating and managing a loan and the cost of capital which is required to be maintained by a bank to grant a loan.
The aggregate of these costs makes up the base lending rate.
The bank’s base rate will allow for price differentiation between various risks undertaken by the bank during its lending operations considering the amount of credit risk that the bank undertakes when a loan is granted.
The bank will be adding a risk premium on top of the base rate to arrive at the effective interest rate which is the actual rate that customers will be charged for the loan granted.
Customers should therefore expect that loan contracts will indicate a base rate and a margin as the effective interest rate.
While base rate will vary from time to time according to changes in money market conditions, the agreed margin will remain fixed as long as the risk profile of the customer does not change.
Considerations for determining the size of the risk premium will arise from the credit risk due diligence process and may include but not be limited to the following: Type of product – e.g. the repayment of a short-term overdraft is more likely than that of a long-term loan because the future carries risks which cannot be quantified at the time of risk assessment.
Therefore, the risk premium (Margin rate) for a long term should be expected to be higher than for a short-term overdraft.
Secondly, a loan to a company that is financially sound and with strong governance has a lower risk of default than lending to a financially weak company or that without a sound governance system.
The company which is financially weak and has poor governance should expect to pay higher risk premium because of its higher risk of default.
In addition, the bank will also be considering the size of expected loss given default to determine the size of the risk premium.
This is where the amount and quality of security comes into play.
If the amount and quality of security is expected to shield the bank from losses in case of default, the risk premium will be lower than when the type and value of security does not offer adequate support to the bank in case of default.
“We are very pleased with this change because it not only offers the bank an opportunity to assess the risk of its customers and assign differentiated pricing between different types of customers and products, but it also puts the bank in a good position to align with the new Central Bank’s price based monetary policy framework,” Toroitich said.
The price based monetary framework is predicated on the expectation that the financial system will be efficient in transmitting monetary policy actions to the market place.
In determining the level of its base rate, the bank will factor in money market cost of funds and/or risk-free investment opportunities and so we shall be able to respond nimbly to changes in overall money market conditions in line with BNR’s new monetary policy framework.