CBK tightens interbank rates to lower credit costs

The Central Bank of Kenya  in Nairobi.


What you need to know:

  • Interbank lending rates are expected to stick below the discount window rate.
  • CBK says the move is not equivalent to loosening of interest rates or monetary policy.

The Central Bank of Kenya (CBK) has tightened the gap between interbank rates, the rate at which banks lend cash to each other in the short term, with its benchmark lending rate as part of new reforms aimed at lowering the cost of credit in the economy.

The reforms involve controlling an interest corridor by setting the upper and lower limits of interbank rates and the CBK emergency loan rates in alignment with the prevailing Central Bank Rate (CBR).

Under the reforms, the interbank lending rates are expected to stay under 1.5 per cent of the prevailing CBR, from 2.5 per cent previously, while the discount window rate — the rate at which banks can tap funds from the CBK as a last resort after exhausting all other avenues, including borrowing from each other — has been lowered to three percent above the CBR from four percent previously.

Reducing inefficiencies

Last August, the CBK approved a new policy framework establishing the two limits with the view of reducing inefficiencies in the interbank market including segmentation of banks by size. It now sees further chances of improving interbank operations and the transmission of its interest rate decisions.

“To enhance the effectiveness of the monetary policy implementation framework, the MPC considered and approved a recommendation to review the width of the interest rate corridor around the CBR from the current 250 basis points to 150 basis points,” CBK noted.

The reforms stemmed from the need to counter segmentation where smaller banks have faced steeper interest rates in the overnight lending market compared to their bigger peers.

For instance, before the adoption of the modernised monetary policy framework, smaller commercial banks often borrowed at costs higher than the discount window rate.

Under the new framework, interbank lending rates are expected to stick below the discount window rate.

This implies that commercial banks unable to access funding from the interbank market should turn to CBK’s discount window for facilitation.

Commercial banks

The discount window provides secured loans to commercial banks on an overnight basis at a penal rate above the benchmark lending rate.

The punitive rate restricts banks from seeking funds in the market only resorting to CBK funds as a last-ditch solution.

While the reforms signal lower interbank rates, the CBK says the move is not equivalent to the loosening of interest rates or the monetary policy.

“This is just a refinement of the current framework just to be able to make it more effective and for the transmission of monetary policy to be more direct,” CBK Governor Kamau Thugge said.