Central Bank lays to rest raging debate on legitimate loan pricing

What you need to know:

Central bank finally issues guidance on the pricing of loans following new law capping interest rates.
There has been an ongoing debate as to whether the CBR, now at 10.5 per cent, or the Kenya Banks Reference Rate (KBRR), currently at 8.9 per cent, is the base rate.

Commercial banks will use the Central Bank Rate (CBR) as the base rate to price loans, the sector’s regulator ruled yesterday.

Central Bank of Kenya (CBK) Governor Patrick Njoroge said in a circular to lenders that the CBR was the legitimate base rate as it is anchored in law.

There has been a raging debate as to whether the CBR, now at 10.5 per cent, or the Kenya Banks Reference Rate, currently at 8.9 per cent, is the base rate envisaged in the Banking Act for purposes of setting the maximum cost of loans chargeable on borrowers. The CBR at the current rate gives commercial banks a higher margin than the KBRR.

“For purposes of section 33 B of this (Banking (Amendment) Act, 2016, the base rate is the Central Bank Rate (CBR). This is in line with Section 36(4) of the Central Bank of Kenya Act,” said Dr Njoroge in the circular.

“The (central) bank shall publish the lowest rate of interest it charges on loans to banks and microfinance banks, and that the rate shall be known as the CBR,” the CBK said, quoting the law that governs its operations.

The CBK said “the interest rates indicated in the Banking (Amendment) Act 2016 will apply on an annual basis.”
The regulator also drew attention to the banks on the requirement for full disclosure on the fees and other charges on loans.

Full disclosure of all charges

“Accordingly, institutions should submit to the Central Bank of Kenya by September 30, 2016 copies of the policies that will ensure full disclosure of all charges and terms for loans to borrowers,” said Dr Njoroge.

But experts have questioned the decision to rely on CBR, saying the use of a monetary policy instrument to dictate cost of loans will see borrowers succumb to external and political factors.

The move will see the Monetary Policy Committee cede great powers to determine what borrowers pay.
This gives the National Treasury an upper hand, allowing it to borrow from the domestic market without affecting the cost of loans to the private sector.

Commercial Bank of Africa, which had adopted KBRR in calculating the rate caps, said the use of the signal rate is likely to tie loan rates to macroeconomic factors outside the credit market.

“One of the challenges is being tied hostage to other factors, which are not lending-related per se,” said Mr Isaac Awuondo, group managing director at CBA.

“We believed KBRR was set up as a lending benchmark. We’ll put out new notices now that we have guidance from the regulator,” Mr Awuondo said in an interview. He said that the lender would now use the CBR as the base.

The Banking (Amendment) Act 2016, which commences today, sets the ceiling for lending rates at four percentage points above the benchmark rate; and sets the floor for deposit rates at 70 per cent above the base rate.