Interbank borrowing rates fall to six-month low on CBK reforms

The Central Bank of Kenya  in Nairobi.

Photo credit: DENNIS ONSONGO| NATION MEDIA GROUP

What you need to know:

  • Interbank rate is the rate of interest charged on short-term loans between banks.
  • Commercial banks usually borrow from each other to fund liquidity shortfalls.

Interbank lending rates have fallen to a six-month low of 12.922 percent on reforms initiated by the Central Bank of Kenya (CBK), which are expected to usher in lower rates for commercial bank loans.

The interbank rate is the rate of interest charged on short-term loans between banks. Banks borrow and lend money in the interbank lending market to manage liquidity and satisfy regulations such as reserve requirements.

The latest data shows that the interbank lending rates now stand at their lowest since December 21, 2023, and mirror the success of the apex bank in bringing charges in the interbank market closer to its benchmark interest.

In August last year, CBK’s monetary policy committee approved a new monetary policy framework to ensure banks passed on the benefits of low lending rates to consumers.

The new framework is based on inflation targeting and is anchored on an interest rate corridor around the Central Bank Rate (CBR), first established at 250 basis points or 2.5 percent.

Earlier this month, the CBK made further amendments and tightened the gap between interbank rates with its benchmark lending rate as part of new reforms aimed at lowering the cost of credit in the economy.

The changes involved 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 stick around 1.5 percent of the prevailing CBR, from 2.5 percent 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.

“The MPC noted that the new monetary policy implementation framework adopted on August 9, 2023, has resulted in improved functioning of the interbank market, narrower interest rate spreads with reduced market segmentation, and improved monetary policy transmission,” the CBK indicated.

Under the framework, interest rates on interbank lending must not go above 14.5 percent or below 12.5 percent with the CBR set at 13 percent.

The measure is expected to see the interbank lending rates closely tracking the benchmark lending rate by the CBK, ensuring any adjustments in the latter have an impact on borrowing costs between banks.

Commercial banks usually borrow from each other to fund liquidity shortfalls on an overnight basis through the interbank market.

Before the upgrade of the framework, sharp spreads on the borrowing rates had emerged with the thinly capitalised smaller banks suffering a hit from higher interbank lending costs.

CBK expects the translation of its policy directions to be more direct in the aftermath of the reforms. “This is 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 noted earlier this month.

The reforms are part of a deal between the CBK and the International Monetary Fund (IMF) after it emerged that commercial banks had been ignoring the CBR when adjusting interest rates to customers.

Borrowing costs by customers are expected to decline in tandem with the interbank rates once the CBK cuts its benchmark lending rate.

Commercial banks unable to borrow from the interbank window are expected to turn to CBK’s emergency overnight facility known as the overnight window, a last resort option for banks.

CBK has also amended the rate charged on the facility from four percent to three percent above the Central Bank Rate or 16 percent at present.

The current interbank rate tracks the interest corridor on the lower end of the CBR signalling relatively cheaper borrowing costs among lenders from the possible 14.5 percent premium.