Eyes on CBK as new bank rate fails to lower cost of loans

Commercial banks, businesses and borrowers will have their eyes trained on the banking sector regulator’s top policy making organ which meets Wednesday to review the cost of loans, even as the first rate set six months ago failed to move the market.

The Central Bank of Kenya (CBK) introduced the Kenya Banks’ Reference Rate (KBRR) six months ago, promising borrowers that it would help to reduce interest rates by making the cost of loans comparable across different banks.

The KBRR has, however, failed to cut lending rates in any significant way, leaving commercial banks to report double-digit profit growth that is mainly driven by high spreads. 

The latest data from the CBK shows that lending rates stood at an average of 16 per cent in October, a marginal drop compared to 16.36 per cent in June last year.

“The marginal decline was despite the introduction of Kenya Banks’ Reference Rate in early July 2014, which was expected to significantly bring down the cost of borrowing,” noted the Kenya National Bureau of Statistics in its third-quarter economic growth report released at the end of December.

High cost of loans is seen as a hindrance to economic growth as it discourages businesses and households from borrowing, while also pushing those with debts into defaults.

Wednesday’s Monetary Policy Committee (MPC) meeting will mark the first review of the KBRR, which is set to be changing bi-annually. The regulator had termed the introduction of the KBRR as the dawn of an era ushering low cost of loans.

READ: Treasury imposes new rules to rein in commercial loan costs

The KBRR was introduced after public outcry over the high interest rates charged by banks. Parliament was pushing for regulation of lending rates but the Treasury, jointly with the banks, eased the pressure by promising to make disclosure of the cost of loans more transparent and thereby increasing competition in the sector.

The banks set up a joint committee with Treasury representatives, which included two Cabinet secretaries who previously served as bank chief executives to formulate the KBRR.

The hopes of lower interest rates had been further fanned by increased external borrowing through the sovereign bond, with the Treasury citing the need to ease pressure on domestic rates as the main reason for its decision to raise cash from international markets.

Banks were to use the KBRR as a common base rate and were allowed to load a premium on to it to determine the total cost of loans to the clients.

The CBK made it a condition for the banks to use the KBRR to price new loans issued from July last year, while giving them a one-year period to ensure all other loans were on the same platform. This meant that lending rates are to change in tandem with a review of the KBRR.

The KBRR is calculated as an average of the 91-day Treasury bill rate and the indicative Central Bank Rate (CBR).

The 91-day T-bill rate has dropped to an average 8.5 per cent in the past two months compared to an average 10.76 per cent in June last year, indicating a likely drop to the KBRR if the CBR is held steady. The current KBRR is 9.13 per cent.

However, data from the CBK shows that lending by commercial banks to the productive private sector has slowed down. The CBK said credit increased by Sh228 billion in the 12 months to October 2014 compared with Sh232 billion in a similar period in 2013.

The introduction of the rate has also not affected banks’ profitability, with the lenders recording Sh126.6 billion in pre-tax profits in 11 months to November last year compared to Sh125.8 billion for the full year 2013.

READ: Kenya banks set for another year of record profits

Analysts interviewed by the Business Daily were split on whether the CBK would retain the CBR at the current level of 8.5 per cent, thereby signalling a small change to the banks’ reference rate.

“They may not do anything because their biggest concern is inflation which is going down,” said economist X.N Iraki, who however said his advice would be for them to cut the rate. Mr Iraki argued that the country needed economic growth, supported by affordable capital.

The inflation rate has dropped in the past four months in a row to 6.02 per cent at end of December. Mr Iraki noted that the recent drop in global oil prices is expected to result in lower inflation rates given room for loosening the monetary policy.

Genghis Capital expects a cut of between 0.5 per cent and 0.25 per cent on the basis of lower inflation.

Some analysts, however, expect the CBK to balk to pressure for a cut.

“Lending rates are a factor of savings availability and demand for investment options. If you artificially keep that low, savings will be discouraged and on the other hand there will be too much demand for investment, especially long-term investments,” said Johnson Nderi, Corporate Finance and Advisory manager at ABC Capital.

Some commercial banks, such as I&M Bank, have factored the KBRR in their deposit rates payable to customers ensuring that a drop in the standard base rate will result in the cost of funds falling, protecting their net margins.

Stratlink Global, a research firm, said the CBK was targeting lower lending rates that were likely to see it cut the CBR.

“Given the uptick in the 91 Day T-Bill rate, the central bank could be compelled to slash its benchmark rate with a view to sustaining the KBRR at favourable single digits,” said the firm.

Aly-Khan Satchu, chief executive of data vending firm Rich Company, said he expected the CBK to hold the rate steady for it 10th sitting in a row, with a probable cut in the second half of the year.

“Recent weakness in the shilling is all about dollar strength and the crude oil collapse will send inflation to the lower band by half year,” he said.

It will also remain to be seen whether banks will pass on the benefit of a lower KBRR to their customers immediately. In the past the lenders have been accused of failing to transmit such cuts.