Showdown looms as banks reject CBK's cheap loans reform plan

 

A showdown is brewing between commercial banks and the Central Bank of Kenya (CBK) over the State-backed proposals aimed at providing cash-strapped Kenyan borrowers with cheaper loans.

The banking industry yesterday rejected CBK Governor Kamau Thugge’s plan to peg loan prices to the benchmark Central Bank Rate (CBR). The CBR is the benchmark rate of interest the banking regulator charges on loans to banks. This rate directly affects borrowing costs in the economy and serves as a key monetary policy tool for controlling inflation, promoting economic growth, and stabilising the Shilling exchange rate.

When the CBK raises the CBR, it signals an attempt to curb inflation by increasing borrowing costs, thus cooling an overheated economy. 

Conversely, when the CBR is lowered, it aims to encourage borrowing and investment, thus stimulating economic growth.

Under the new radical CBK reforms, the State also proposes to subject banks’ loan mark-ups to regulatory scrutiny.

The CBK, in a recently released consultative paper reviewing the Risk-Based Credit Pricing Model, advocated for the CBR as the base reference rate for all loans. 

Operating costs

Under Thugge’s proposal, final lending rates would be determined by adding a premium, denoted as “K,” to the CBR. This premium would encompass a bank’s operating costs, shareholder returns, and the borrower’s risk profile, with the CBK intending to review each bank’s proposed “K” before implementation. 

While the CBK has not explicitly stated an intention to cap rates, the banking sector interprets this review process as a form of price control.   But the banks through their lobby the Kenya Bankers Association (KBA) yesterday in a notice opposed the plan, alleging that the proposals as fronted by the CBK amount to a form of interest rate capping or price control. 

This standoff between banks and the banking regulator deals a significant blow to President William Ruto’s administration’s push for cheaper loans, a key component of his economic agenda to stimulate credit growth and support businesses. The KBA in a swift rejoinder yesterday rejected the CBK’s proposal, asserting that it effectively constitutes interest rate capping and is not supported by law. 

The KBA argues that such a measure would stifle lending, particularly to Micro, Small, and Medium-sized Enterprises (MSMEs), echoing the perceived negative impact of previous explicit interest rate caps between 2016 and 2019. 

The lenders contend that the proposed review of their premium would also undermine the CBK’s monetary policy transmission mechanism by preventing market rates from responding effectively to changes in the CBR. 

Furthermore, they argue that it would hinder their ability to meet public commitments to support small businesses with substantial loan disbursements.

Instead, the KBA has proposed the adoption of the interbank rate as the base reference rate, advocating for a market-driven approach with a fully flexible premium “K.”  The bankers argue that this aligns with global best practices, where market-based rates derived from short-term market indicators are the norm. 

They also point to the failure of a previous unified base rate, the Kenya Banks Reference Rate (KBRR), which they say did not benefit from a supportive monetary policy framework. 

The KBA emphasises that the interbank market, closely aligned with the CBR, is the most effective anchor for transmitting monetary policy signals, a mechanism they fear would be weakened under the CBK’s proposal.  

The bankers are particularly concerned about the impracticality of submitting the premium “K” for each customer to the CBK for review, as well as the lack of clarity on the criteria for this review.  They also raise concerns about the CBK’s silence on the interbank market corridor as a monetary policy implementation framework, questioning whether the central bank intends to abandon this crucial tool.

While the CBK argues that the interbank market is prone to volatility, the KBA counters that it is the central bank’s mandate to manage market liquidity and mitigate such volatility using its monetary policy instruments. 

The KBA also disputes the CBK’s assertion that the CBR reflects the cost of funds for banks, arguing that deposit rates are typically benchmarked against Treasury bill rates, reflecting depositors’ opportunity costs.

President Ruto and Governor Thugge have publicly urged banks to lower lending rates, emphasising the detrimental impact of high loan costs on the economy.

  Ruto has pointed to the success of the State-backed Hustler Fund, which offers single-digit interest rates, as evidence that banks can profitably lend at lower rates.