Introduction

Cedispay is a digital institution that provides financial services to underserved individuals and microenterprises in Ghana. Cedispay's pricing model is designed to ensure that loan terms are suitable for the economic activities of customers, and interest rates and installments reflect what microenterprise activities earn.

Cedispay Pricing Model

The Cedispay pricing model is calculated separately for personal and business loans based on the inherent risk in each product and the specific customer's risk. The pricing model consists of five elements that determine the interest rate charged to customers:

1. Cost of funds: This is calculated based on Ghana reference rate or (interbank) swap rate plus markups for liquidity risk and optionality risk
2. Cost of operation or cost-to-asset ratio: This is calculated as the previous year's Cedispay cost of operations divided by the loan amount
3. Cost of credit risk or Expected credit risk ratio This is the provision of credit risk on the profit or loss statement in the previous year divided by the average loan amount
4. Customer-specific risk premium: This is determined based on the customer's credit score and historical loss rates
5. Desired profit margin: This is the average of the return on capital (ROE) of the banking industry in Ghana for the most recent 5 years

Please note that in addition to the interest rate charged to customers, CedisPay also charges a separate processing fee of 3% for new customers. This processing fee represents the cost of operations. To avoid double counting, the interest rate computed using the five components will be adjusted by 3% to account for the processing fee

Cost of Funds

The cost of funds is the interest rate that CedisPay pays to borrow money from other sources. It includes the cost of deposits, wholesale funding, and any other sources of funding. This cost is usually expressed as a percentage.

Cedispay determines its cost of funds based on the Ghana reference rate or (interbank) swap rate plus markups for liquidity risk and optionality risk. The Ghana Reference Rate (GRR) is a benchmark interest rate used in Ghana's banking industry. It is a weighted average of the interest rates of the 91-day, 182-day, and 1-year government of Ghana treasury bills, which are considered risk-free investments. The GRR serves as a benchmark for determining interest rates on loans and other financial products in Ghana, as well as for measuring the performance of financial institutions in the country. The Ghana Bankers Association and Bank of Ghana calculates and publishes the GRR on a regular basis. The specific markups for liquidity risk and optionality risk are calculated by Cedispay using the following methods:

1. Liquidity Risk Markup: This markup compensates for the risk that an asset may not be easily sold in the market, leading to increased costs for Cedispay to manage its liquidity position. To calculate the liquidity risk markup, Cedispay estimates the cost of holding the asset for a given period, based on factors such as market volatility, trading volumes, and bid-ask spreads. Cedispay then adds a markup to this cost to compensate for the liquidity risk
2. Optionality Risk Markup: This markup compensates for the risk that an asset may have uncertain cash flows or may be subject to unexpected events that affect its value. To calculate the optionality risk markup, Cedispay uses option pricing models to estimate the probability of certain events occurring and the impact of these events on the asset's value. Cedispay then adds a markup to the asset's expected return to compensate for the optionality risk

It's worth noting that the specific markups for liquidity risk and optionality risk will vary depending on the asset class and the specific asset being considered. Therefore, Cedispay uses different methodologies and assumptions for different assets in order to calculate the appropriate markups

Cost of Operations

The cost of operations includes all the expenses incurred in running CedisPay such as salaries, rent, utilities, and marketing expenses. This cost is usually expressed as a percentage of the loan amount. Operating costs are calculated by dividing the previous year's costs by the loan amount. Calculating the cost of operations includes the following:

1. Identify all operational expenses: The first step is CedisPay identifies all the expenses that go into processing and servicing a loan, including personnel costs, rent, utilities, technology expenses, and any other overhead costs
2. Allocate expenses: Once all expenses have been identified, CedisPay allocated to the specific loan products. For example, personnel costs can be allocated based on the amount of time spent processing and servicing each loan type
3. Determine loan volume: To accurately calculate the cost of operations for each loan product, CedisPay determines the loan volume for each product. Loan volume is the total amount of loans originated by CedisPay in a specific period
4. Calculate cost per loan: Once you have identified all expenses, allocated them to each loan product, and determined the loan volume, CedisPay calculates the cost per loan by dividing the total cost of operations for that product by the loan volume for that product
5. Add desired profit margin: Finally, lenders can add their desired profit margin to the cost per loan to arrive at the minimum interest rate they should charge for the loan

By following these best practices, lenders can accurately calculate the cost of operations and ensure that their loan pricing is fair and profitable

Expected default rate or Cost of credit risk

The expected default rate is the percentage of loans that are expected to default based on historical data or other relevant factors. This rate is usually expressed as a percentage. The cost of credit risk is calculated by dividing the provision for credit risk on the profit or loss statement from the previous year by the average loan amount

Desired Profit

Cedispay's desired profit is based on the average return on capital (ROE) of the banking industry in Ghana for the most recent five years. This is calculated as the ROA (return on assets), which represents the desired profit margin

Customer-Specific Risk Premium

Cedispay's risk-based pricing model includes a customer-specific risk premium based on the customer's credit score, which is calculated based on several factors, including repayment history and credit utilization. Baseline Risk Premium: The baseline risk premium is determined as the average ROE of the banking industry in Ghana for the most recent five years minus the assumed Risk-Free Rate (RFR), which is the one-year government bond or the Ghana Reference Rate Increases (GRR).

Credit Score Ranges and Associated Risk Premiums: Cedispay credit scores range from 0 to 100 and are split into four brackets based on the credit score:

1. 81-100: Credit score is the baseline risk premium
2. 71-80: Credit score is the baseline risk premium plus historical loss rate on the product
3. 61-70: Credit score is the baseline risk premium plus historical loss rate on the product multiplied by 2.
4. 0-60 (Bad): Credit score is the baseline risk premium plus historical loss rate on the product multiplied by 3