Kenya's banking sector has undergone a significant change following the Central Bank of Kenya's introduction of a risk-based pricing (RBP) framework for loan interest rates. The reform, which began phasing in last year, links loan pricing to the Kenya Shilling Overnight Interbank Average Rate (Kesonia) and a bank-specific risk factor.

Impact on Non-Performing Loans

Data from Credit Reference Bureaus (CRB) reveals that large Tier 1 banks have seen a notable reduction in non-performing loan (NPL) rates on commercial lending, dropping from 17.26% to 5.43%. This improvement largely reflects balance-sheet adjustments, including write-offs and borrower-initiated restructures, rather than immediate underwriting enhancements.

Similarly, smaller loans under Sh1 million at these banks recorded NPL declines to 5.19%, suggesting tighter credit standards for SMEs under the new pricing model. However, big-ticket loans over Sh1 billion at Tier 1 banks experienced a slight rise in defaults, increasing from 14.92% to 18.18%, underscoring persistent risks in large exposures.

Challenges in Mid-Tier and Smaller Banks

Tier 2 banks generally improved across most loan categories, except for unsecured consumer loans between Sh10,000 and Sh100,000, where defaults surged from 27.91% to 44.82%. This segment, vulnerable due to thin debt servicing capacity, appears to have been squeezed by higher risk-based rates, pushing marginal borrowers into default.

Tier 3 banks saw a modest increase in consumer loan defaults by 1.33%, while their largest commercial loans worsened from 48.15% to 50%. Microfinance banks showed steady but high NPL levels (27-34%) in consumer loans, indicating limited change from the pricing reform given their focus on higher-risk clients.

Looking Ahead

The RBP framework has equipped banks with better tools to price and manage credit risk, leading to faster loan growth where risk appetite has expanded. However, the rise in defaults among mid-sized retail borrowers and large exposures at smaller banks raises concerns about the sustainability of these trends.

Future CRB data will be critical in assessing whether banks can balance risk pricing with borrower capacity, particularly for vulnerable segments facing higher borrowing costs. Overall, Kenya’s banking sector shows cautious optimism, with systemic cleanup in large banks balanced against emerging risks in other market segments.