The Kenya Bankers Association (KBA) has opposed the Central Bank of Kenya’s (CBK) proposal to use the Central Bank Rate (CBR) as the base reference rate, with final lending rates determined by adding a premium (“K”) to the CBR.
In a statement on April 30, KBA Chief Executive Officer (CEO) Raimond Molenje explained that the premium ‘K’ shall comprise the bank’s operating costs related to lending, return to shareholders, and the borrower’s risk premium.
CBK will review each bank’s proposed premium ‘K’ before rollout and determine both the base rate and the premium ‘K’ (Interest Rate Capping).
KBA said the proposed interest rate capping by CBK is not supported in law and would have adverse effects on the economy.
The Association stated that the proposal will reduce lending to Kenyans and businesses, especially MSMEs, as experienced between 2016 and 2019 when the interest rate capping law was in place.
Additionally, the CEO said CBK will not operationalize the monetary policy decision after setting the CBR.
“Setting the CBR without triggering its transmission leads to misaligning market outcomes from the policy,” KBA said.
Besides, Molenje said banks will not be able to honour KBA’s commitment to support small businesses with loans of Ksh150 billion annually from 2025.
Kenya Bankers Association Proposals to CBK
Molenje said KBA proposed to CBK for the adoption of interbank rate as the base reference rate, that is, market-driven and allowing the premium ‘K’ to be fully flexible and underpinned.
KBA said the global best practice shows that market-based rates are derived from short-term market rates, such as the SOFR(USA), SONIA(UK), and EURIBOR (EU), which are all K derived from short-term market rates.
Further, the Association stated that previous efforts toward a unified base rate, such as the Kenya Banks Reference Rate (KBRR), were ineffective because they lacked a supportive monetary policy framework and required the Central Bank of Kenya (CBK) to actively enable the transmission of policy actions.
Also Read: CBK Explains Proposal for Fair Bank Loan Rates
“Its design did not benefit from CBK actively operationalizing its policy decisions. The interbank market (aligned with the CBR) is the best anchor for transmitting monetary policy signals,” KBA said.
“There would be a weak transmission of policy signals if CBR is not operationalized via liquidity injections/withdrawals.”
KBA emphasized that flexibility on the premium ‘K’ is consistent with the law that recognizes a liberalized interest rate regime in Kenya.
It maintained that beyond the base rate, ‘K’ should be allowed to be fully flexible across banks, products, and clients based on each bank’s differentiated cost of funds, operational costs, shareholders’ expected return on investment, and customers’ risk premium.
“All customers, including those with very high credit risk levels (such as low-income individuals and small businesses), should have access to loans to finance their activities at interest rates commensurate with their risk profiles,” the Association said.
Interbank Market Corridor
KBA pointed out CBK’s silence on the interbank market corridor as the monetary policy implementation framework in its proposal.
The Association said silence raises concerns about whether CBK has abandoned the interest rate corridor framework and whether the market still needs to consider the interbank rate as the operational target for monetary policy.
It explained that ignoring the interbank rate sets the market back to the pre-August 2023 challenges of CBR being misaligned with market conditions and, therefore, weaker transmission of policy.
“The proposed rate capping is dangerous without clarity on the criteria for reviewing the proposed ‘K’; submitting to CBK the premium ‘K’ for each customer is impractical,” KBA said.
Also Read: CBK Announces Plans to Change Lending Rate Model
CBK argued that the interbank market is prone to volatility during periods of tight liquidity.
However, KBA said the Constitution and the CBK Act mandate CBK to apply its monetary policy tools to manage market liquidity conditions and mitigate volatility.
CBK indicated that the CBR reflects the cost of funds for banks.
KBA stated that two main factors determine the cost of funds for banks: the cost of deposits and the cost of long-term borrowed funds.
“The rate of return on commercial bank deposits is not benchmarked on CBR but rather the depositors’ assessment of the opportunity cost of investing in Government securities, which is reflected in the treasury bill rate,” the Association said.
KBA Rejects CBR But Ready for Engagements
Molenje said KBA does not support the CBK proposal in its entirety.
KBA stated that by rejecting the interbank rate as the preferred unified base rate and proposing a new CBR, the CBK will not operationalize the policy decision after setting the CBR.
The Association affirmed that the reintroduction of interest rate capping contravenes the law that prescribes market-driven interest rates.
It stated that interest rate controls will drive banks to stop lending to segments of the economy that are perceived to be risky, such as small businesses and low-income individuals, stagnating economic growth and development, employment creation, and investment.
However, Molenje said the banking industry stands ready to engage and work with CBK to address the challenges in credit pricing, transparency, and realize affordable credit flow to Kenyans, their households, and businesses.
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