CBK plans control of inter-bank rate to aid loan pricing

Central Bank of Kenya (CBK) is set to control the rate at which banks lend each other (interbank) so as to make its policy rate more effective in swaying inflation and helping lenders price loans better.

The CBK is set to implement an ‘interest corridor’ — setting the upper and lower limits — aligning the interbank rates with the Central Bank Rate (CBR), the International Monetary Fund (IMF) disclosed in a statement.

The efficiency of the CBR on inflation and exchange rate has been at times limited by the free movement of the interbank rate which may still provide liquidity in the market at a time the CBK is mopping up cash to rein in inflation.

“To achieve their inflation objective, the authorities will align the interbank rates with the policy rate and formally announce and implement an interest corridor,” reads part of the IMF statement. Banks usually lend to each other through the interbank window with dominant large banks, which enjoy high liquidity, mainly lending to rivals largely on own terms.

Introduction of the interest corridor in a market involving two willing players will be a divergence by CBK from its advocacy against regulation of interest rates.

The CBK had not responded to the Business Daily queries on the matter by the time of going to press.

“IMF has been pushing for this for some time. There has been lots of volatility in the market making it hard for banks to price their products as the interbank payments have to be factored in as interest expense,” said a multilateral agency source who cannot be named without compromising his position.

He noted the efficiency of the interbank market depended on the CBK’s supervisory ability in assuring the market that all players were safe and sound.

Large banks are usually selective on the smaller banks they lend due to fears of a lender collapsing and failing to repay as was the case with Dubai Bank and Imperial Bank.

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As a result the interbank market has few players and its pricing swings wildly depending on the level of liquidity.

Tuesday banks were lending each other at 3.8 per cent compared to 25.8 per cent six months ago in mid-September. The policy rate has remained constant at 11.5 per cent.

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The central bank which also lends to banks through instruments referred to as reverse repos was charging 11.55 per cent.

Analysts attributed the wide gap between the reverse repo (banks get cash from CBK) and the interbank rate to mistrust among lenders.

Banks with excess liquidity are willing to lend cheaply to peers they trust while locking out those they consider risky even with the promise of higher returns.

“The way to reverse this is introduce collateral as is the case with horizontal repo but go a step further and allow transfer of security so that in case of default a bank can sell the security,” said Alex Muiruri head of fixed income at Kestrel Capital.

Currently banks use Treasury bills and bonds as security for horizontal repos but are not allowed to sell on default.