Fund managers say rate cap to hit monetary policy

A majority of fund managers and fixed-income analysts polled by a research firm say the capping of bank rates will water down the effectiveness of monetary policy in controlling credit supply and inflation.

The financial players polled by Nairobi-based financial research firm HTM Capital also faulted the use of the Central Bank Rate as the benchmark for pricing bank loans.

The Banking (Amendment) Act 2016 capped the interest rate on loans at no more than four per cent above the base rate set by Central Bank of Kenya (CBK), which has officially been interpreted to be the Central Bank Rate (CBR) even though there exists a Kenya Banks Reference Rate (KBRR).

Eight out of 10 respondents in the poll said the rate capping would have a negative impact on monetary policy transmission, with two saying it would have a positive impact or no effect at all.

“We think capping of interest rates will cause confusion, especially should inflation overshoot and MPC (Monetary Policy Committee) needs to raise the policy rates. This will negate the original intent (cutting rates) of the capping,” HTM reported the respondents as saying.

“CBK independence may have been compromised…the monetary policy mechanism is unlikely to raise interest rates to keep bank credit supply lower, even if there is a need to do so.”

Other than the portfolio managers and fixed income analysts from investment companies, HTM also polled dealers from treasury departments of commercial banks and economists from private and public institutions.

Nine out of 10 respondents said the CBR is not the appropriate benchmark for loan pricing, arguing that it is a policy signalling tool that is effected through other rates such as the repurchase orders (Repo) rate.

“There are instances where the CBR is changed to address broader macro stability issues not linked to credit demand. A market-based rate reflecting demand for private debt would be preferable, for example yields on liquid corporates,” said HTM.

READ: IMF says rates capping could erode Central Bank autonomy

“Probably a blend of inter-bank rate and T-bill rate is more alive to the activity level in the money and deposit market (funding side) and asset prices (substitute market).”

In a note on the rate cap done last month, Citi Africa chief economist David Cowan also pointed out some likely problems for the MPC due to the adoption of CBR as the loan pricing tool.

Among them would be increased political pressure on the MPC to cut rates even when it may not wish to do so in the first place, a concern that had also been raised by the IMF.

“Another potential problem would arise for the MPC if T-bill rates were to rise significantly above the CBR rate, as in this case the incentive for banks to hold government securities, rather than lend to commercial borrowers, would rise significantly,” said Mr Cowan.

The law was signed into law at a time CBK was easing monetary policy, meaning that it was in line with the spirit of lowering interest rates.