Treasury gets an upper hand in fight with banks over cost of loans

The Central Bank of Kenya yesterday identified the Central Bank Rate (CBR) as the tool that commercial banks must use in their pricing of loans, effectively shielding the government’s rising appetite for local borrowing from determining the cost of credit in the new dispensation of interest rate controls.

CBK Governor Patrick Njoroge confounded industry players with his mid-day announcement that threw the Kenya Banks’ Reference Rate (KBRR) out of the window in favour of the product of a boardroom decision by the Monetary Policy Committee (MPC). 

“The base rate is the Central Bank Rate, (CBR)” the CBK said in banking circular No. 4 of 2016 issued yesterday and sent to all bank executives.

The decision, which comes into force this morning, is seen as exposing borrowers to external and political considerations – and not purely economic factors – in the pricing of credit.

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“It means the MPC will lock itself in a room using information that is only known them to determine the cost of loans,” said Jeremiah Owiti of the Centre for Policy Analysis and Research (CPAR).

KBRR, which currently stands at 8.9 per cent, is a tool that the CBK jointly established with the commercial banks and which factors in the government’s short-term borrowing – in the pricing of credit.

The Central Bank Rate currently stands at 10.5 per cent.

Use of the CBR as the base rate in the pricing of credit puts immense powers in the hands of the Monetary Policy Committee who may use it to kill several birds with one shot.

It enables the MPC to control for external factors such as the price at which the government is borrowing while pricing loans – meaning the State can increase its borrowing from the domestic market without the fear of impacting financial markets negatively.

The decision gives the National Treasury an upper hand to order banks to lend at a certain price regardless of its own behaviour in the credit market.

Macroeconomic factors

Commercial Bank of Africa, which had adopted KBRR in calculating the rate caps, said 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 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.

The Banking (Amendment) Act 2016, whose effective date is today, sets the ceiling for lending rates at four percentage points above the benchmark rate and sets the floor for deposit rates at not less than 70 per cent the base rate.

This means the interest rate ceiling on loans is for the time being set at 14.5 per cent while the floor for saving and term accounts stands at 7.35 per cent.

The CBR is reviewed and announced by the MPC at least every two months or whenever necessary, and is used as a policy tool to curb inflation, stabilise the local currency, and manage liquidity.

KBRR is on the other hand calculated as an average of the CBR and the two-month weighted moving average of the 91-day Treasury bill rate.

The CBK’s decision means that the cost of loans will not change in the event of a cash crunch that forces the government to go on a borrowing spree, and which in turn results in higher rates for government papers.

Analysts at management firm Cytonn said the use of CBR which disregards developments in the money markets will result in pricing differences between government borrowing and the capped interest rate for banks.

Cytonn also argued that the CBR is not the appropriate pricing tool as it ignores other market participants’ view of the interest rates environment, giving MPC the full authority to determine loan pricing.

“This will result in pricing inefficiencies as government and private sector will be accessing funds in the markets at different and unrelated pricing,” said Maurice Oduor, investments manager at Cytonn.

“The government’s borrowing appetite and loan pricing to private sector have effectively been separated since KBRR used to be the meeting point for the two metrics,” said Mr Oduor.

A bank chief executive questioned the efficacy of the CBR, saying it has never been used by the regulator when advancing loans to lenders in distress.

“I have never seen the CBR apply. CBK uses the T-Bill rate plus a penalty factor,” said the chief executive who spoke on condition of anonymity.

Another chief executive of a mid-tier bank termed CBK’s decision as “a dangerous step,” arguing that loan pricing should be controlled by the T-Bill rate and the yield curve.

“If government continues to borrow at 14 per cent per annum (on term paper) then how will banks attract deposits when the lending rate has been pegged at below 13 per cent per annum?” asked the bank boss who requested for anonymity. “CBR could even come down if monetary policy factors so dictate but T-Bills, like we saw recently, are also a measure of the government’s appetite to borrow. As a banking practice, KBRR was the reference rate,” said the CEO.

The CBK Act (2015) defines CBR as: “The bank shall publish the lowest rate of interest it charges on loans to banks and microfinance banks, and that rate shall be known as the central bank rate.”

While introducing the KBRR in July 2014, the banking regulator said it was “a uniform base lending rate across the banking sector to enable consumers compare the pricing of loan products.”