If you have an existing bank loan, you have probably received a notice explaining changes in how your interest rate is calculated. This follows the Central Bank of Kenya (CBK) overhaul of the credit-risk pricing framework commercial banks will use to determine lending rates. The first phase of the changes took effect in September last year, with the final transition completed in February this year.
Under the new framework there are two benchmark rates. The first is the Kenya Shilling Overnight Interbank Average Rate (Kesonia).
This is the interest rate banks charge each other when lending overnight in the interbank market. The second benchmark is the Central Bank Rate (CBR), the policy rate set by the Monetary Policy Committee and announced by the CBK Governor.
While the CBK indicated Kesonia as the preferred benchmark, it allowed banks the option to continue using CBR. Some lenders, including large banks, have opted to use CBR largely due to system readiness and legacy internal pricing frameworks. Others have fully transitioned to Kesonia.
Currently, Kesonia rates are slightly higher than the CBR. While the CBR remains relatively stable between Monetary Policy Committee meetings, Kesonia is a market-driven rate that reflects actual liquidity conditions in the banking system.
The difference between the two benchmarks is largely driven by liquidity variations across banks. Some banks mobilise deposits more effectively, while others rely more heavily on the interbank market for short-term funding.
This liquidity dynamic within Kenya can be better understood by looking at it at market level. For example, comparing Kenya with regional markets, Kenya’s non-performing loan (NPL) ratio, which indicates the levels of credit risk, is significantly higher than in neighbouring Tanzania and Uganda. Today, Kenyan banks report NPL levels above 15 percent, compared to about 5 percent in those markets.
Despite this higher credit risk, lending rates across the three countries remain broadly similar, typically between 15 percent and 18 percent. From a pure risk-return pricing perspective, lending rates in Kenya might be expected to be higher. However, Kenya has a stronger financial market and a larger retail deposit base. Banks are therefore able to mobilise relatively cheaper and more stable local funding compared to neighbouring markets.
In perspective, status of liquidity will be more responsive and should drive pricing of funds, making Kesonia a better market barometer. As the wars in Ukraine and Iran continue to affect global economy, inflation transmission will create more volatility in liquidity and will trigger even more difference between CBR and Kesonia.
At present, institutions using the CBR benchmark may experience slightly lower pricing relative to market conditions. Although the difference between CBR and Kesonia appears small, over time the cumulative impact could become significant. Competitive pressures and shareholder expectations will gradually push banks towards the market benchmark rate, Kesonia.
This policy shift allows CBK to achieve quick monetary policy transmission while incentivising financial institutions to lend more to MSMEs, who would otherwise be denied credit if the interest rates was not risk-based. For borrowers, the new framework allows those with good credit scores to benefit from lower interest rates.
Borrowers need to know that, Kesonia and CBR aside, the biggest driver of their loan pricing remains the risk premium. Customers with strong credit scores typically enjoy lower overall borrowing costs. Those with weaker repayment records now face higher premiums and the long-term consequences of impaired credit ratings.
The writer is the CEO, Metropol Credit Reference Bureau.
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