Saturday, November 1, 2008

Full disclosure of hidden costs

eastafrican standard

Published on 13/10/2008

By James Anyanzwa

When planning to secure a loan from commercial banks, the most difficult task for a borrower is to decide on which bank charges relatively lower interest rate.

With the cost of living rising everyday a shilling saved on borrowed funds could make a major difference in uplifting the economic welfare of many households.

Even though the actual interest rate on a loan may appear cheaper in the first instance, the borrower ends up paying more on the loan due to additional charges (mostly hidden costs) that are mostly not taken into consideration during the time of loan negotiations.

This perennial inability of loan seekers to decide on relatively cheaper banks could, however, be a thing of the past with the launch of an annual percentage rate (APR) or total cost of credit

APR measure takes into consideration all the extra charges associated with various loan facilities offered by different banks and enables borrowers.

The rate currently widely used in the US, Europe and Australia empowers consumers with a means to compare different credit and loan offers.

APR, which is an all-inclusive measure of the cost of credit, is expected to lower bank charges, which have locked out a substantial portion of the population from accessing credit.

Feasibility study

The Central Bank of Kenya (CBK) in collaboration with the Kenya Bankers Association is working towards introducing this measure.

A South African financial services firm, Genesis Analytics, has won the tender to carry out a study on the feasibility of the instrument in Kenya.

According to CBK, the APR measure study will be Kenya specific.

CBK told Shillings & Sense the study would undertake to analyse key background factors on the demand side to arrive at this measure.

These include among others educational levels, evidence of financial literacy and current financial service usage.

In addition, the banking regulator said the study would undertake a review of experiences in other markets where APR measures have been adopted but take into account the realities of the circumstances in Kenya.

"The study is still ongoing but should be complete by the end of this year," said CBK.

APR is a total cost measure of credit/loan being offered and includes interest rates to be paid and fees associated with a loan.

"The lower the APR, the better the deal for a customer who shops around," says CBK.

APR is designed to provide a standard measure of comparable interest rates for lending (and to a lesser extend saving/deposit).

"There is no standard measure of interest rates in Kenya such as APR or total cost of credit approaches used elsewhere," the bank said.

The move is part of CBK’s efforts to develop and improve competition in the financial sector.

APR is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan.

This includes any additional fees or additional costs associated with the transaction.

Loans or credit agreements can vary in terms of interest rate structure, transaction fees, late penalties and other factors.

A standardised computation such as the APR provides borrowers with an instrument to compare rates charged by lenders.

"Information is a vital element in the development of competitive markets," says CBK.

Based on an earlier survey on bank charges and lending rates launched by CBK in August last year, the costs (excluding additional charges) charged by 20 banks to obtain a loan of Sh50, 000 repayable over a period of two years rose by 0.5 percentage points during the period.

In the higher end of the credit market, interest rate on a loan of Sh500,000 repayable over a three-year period fell 0.01 percentage points.

Expensive banks

The survey showed that Co-operative and Victoria Commercial banks offered the cheapest rates in the lower credit market segment providing loans to the tune of Sh50,000. The two banks both charged a rate of 13.5 per cent.

Dubai Bank and CFC Stanbic (formerly Stanbic Bank Kenya) were the most expensive bank in this segment charging 20 per cent and 20.75 per cent respectively on a similar amount of loan.

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