CBK now targets interbank rate to cap money flow

Banking sector regulator has moved to strengthen the effectiveness of its policy signals with the change in regulations that pegs interbank lending on the Central Bank Rate.
Commercial banks are now required to fix the interest changed on overnight loans to rival banks within the narrow confines of plus or minus two per cent of the policy rate.

CBK’s declaration that it will engage in aggressive liquidity mop-up each time the interbank rate — cost of borrowing between banks — falls two percentage points below the CBR, is expected to secure the high interest-rate regime and cap inflation for at least a month longer.

The CBR is currently at 16.5 per cent while the interbank rate has dropped to 12.3 per cent, placing the Central Bank of Kenya on the path to increased market intervention in the coming weeks to push up the rate.

If the interbank rate rises above the CBR by more than two per cent, CBK will inject liquidity in the market, protecting banks from borrowing at the higher CBK overnight rate, currently at 22.5 per cent.

“The current guideline for the interbank rate is that it should be within plus or minus two per cent of the CBR. If the interbank rate is below the CBR by more than two per cent, this will invite aggressive mop-up of liquidity,” said the Monetary Policy Committee (MPC), CBK’s decision-making arm of the Central Bank.
Analysts said that the declared intention of keeping the interbank rate at above 14 per cent could have informed banks decisions when issuing notices of their base lending rates reduction. The banks stated that the reviews take effect at the beginning of September, when the MPC meets again to review the policy rate.
The returns from Treasury bills and fixed deposits are expected to hold at around thirteen per cent as banks consider the opportunity loss of investing in the interbank market.
Savvy depositors could demand high rates on their money once they figure out that banks need it to avoid the punitive interbank and overnight borrowing from Central Bank.

“The CBK is trying to make the CBR relevant. If the interbank rate goes low, it will lead to increased liquidity forcing it to start tightening again — so it is seeking to provide more clarity in the monetary system using CBR,” said Francis Mwangi, an analyst with Standard Investment Bank.

During the short macro-economic crisis experienced last year, the CBR was exposed as irrelevant in the market, forcing the Central Bank to start putting in place guidelines that would ensure the policy rate cued the market in the desired direction.

“CBK wants to build confidence in the market and make the market more responsive to its actions,” said Alex Muiruri, a fixed income analyst at African Alliance.

Though the MPC had stated it would use repurchase agreements — commonly referred to as Repos — and term auction deposits (TAD) to mop up liquidity, Mr Muiruri suggested that their recent willingness to accept higher yielding T-bills indicated that they had turned to the government securities to withdraw cash from the system.

Treasury bills will lock out the cash from the system for longer as their maturity period is three months while Repos have seven-day maturity periods and TADs, 28 days.

This has resulted to the 91-day T-bill rate rising to 13.2 per cent in the last auction while Repo rates fell from 14 to 11.7 per cent during last week.

CBK’s new emphasis on the CBR has been linked to the fact that mobile money innovations have made it difficult for the regulator to predict behaviour of money in the market, forcing it to change the way it manages the economy.

The Central Bank has in the past ensured macro-economic stability by looking at the amount of cash held by individuals and injecting or withdrawing money from the system depending on how much they perceived was required.

Financial developments have, however, reduced cash being used in the economy, making it difficult to predict the demand for money.

“Expanding financial inclusion in Kenya has resulted in unstable money multiplier and velocity of money, both of which have detrimental effects of undermining predictability of demand for money leading to adverse expectations,” said CBK Governor Njuguna Ndung’u recently in Kigali.