CBK to enforce interbank rate controls on IMF push

The Central bank of Kenya (CBK) has committed to enforce control over interbank rates — the rate at which banks lend to each other, with its benchmark lending rate through a new interest corridor to lower the cost of credit in the economy.

The CBK has agreed to implement the reforms to control short-term interbank rates and target long-term inflation as part of the agreement with the International Monetary Fund (IMF) with the government to access the Sh257 billion loan facility.

The corridor involves setting the upper and lower limits of interbank rates in alignment with the prevailing Central Bank Rate (CBR).

Closer alignment of the interbank and policy rates will help the Central Bank keep inflation within the medium-term target of 2.5-7.5 percent.

“The monetary policy decision-making process could be strengthened by having the MPC pursue a baseline interest rate path to converge to the inflation target based on the results of the forecast and the policy rule within a two-year horizon to improve decision making,” CBK said in a policy paper published on Tuesday.

The changes come after IMF noted that banks ignored the CBR the benchmark the CBK sets every two months when adjusting lending rates to customers. The current CBR stands at seven percent where it has remained for the ninth consecutive Monetary Policy Committee meetings.

The shift from monetary targeting to interest rate targeting has been pushed by the IMF for over a decade with the Central Bank wary of its negative effects.

Kenya joins Uganda, Mauritius, Ghana, and South Africa in adopting the changes and Dr Njoroge said all these countries have faced challenges with the model leading to spiraling inflation from currency, imports, and food prices.

“The review showed that countries in Africa that have adopted inflation targeting have experienced significant deviation of inflation from target that emanated from various sources,” said Central Bank governor Patrick Njoroge.

“This included external shocks (South Africa), fiscal dominance and supply-side constraints on food prices (Ghana), structural liquidity challenges (Mauritius and Uganda), and volatility of the exchange rate (Uganda),” he said.

CBK also noted that big banks declined to lend to smaller banks at the interbank market which has created skewed liquidity.

Big banks feel smaller lenders are not secure and charge higher interbank rates or refuse to lend them money when they need liquidity.

The apex bank said it will develop the repo market-working with Central Security Depository to transfer securities, harmonize contract documentation and improve the enforceability of contracts.

The Repo-Reverse Repurchase agreement where banks sell short-term papers to CBK with a promise to buy them later or discounted Treasury bills.