The Central Bank of Kenya (CBK) has poured cold water on a proposal by commercial banks to use the interbank rate as a reference rate for determining the pricing of consumers' loans, saying it will not accurately reflect their true cost of funding.
A consultative paper published by the CBK on Tuesday on the planned review of the present risk-based pricing model, has highlighted the different views between the CBK and banks, in determining the base rate of loans as the risk-based pricing model is ushered out on account of inefficiency and lack of transparency.
On April 10, banks sent the CBK a proposal that has a two-month average of the overnight interbank rate as the new unified base rate for pricing loans.
They would then add a premium that they will determine competitively, based on their products and clients to reflect the principles of market-driven interest rates and risk pricing.
This means that banks would not need CBK approval for the premium, similar to the premium that was levied in the now abandoned Kenya Bankers Reference Rate (KBRR).
“This proposal of the premium being determined solely by the banks without any reference to CBK is a replica of how the premium was determined during the (KBRR regime. It resulted in a myriad of premia across the banks and was one of the key challenges that led to the suspension of KBRR,” said the CBK in the consultative paper.
The CBK is on its part proposing to use the Central Bank Rate (CBR) as the base for pricing loans, saying it captures the cost of funding for banks more than the interbank rate, which it says is more a reflection of the level of short term liquidity in the market.
This CBK proposed regime will also have a premium added to the base rate determined by banks’ operating costs related to lending, return to shareholders and the a borrower’s risk premium.
This premium will also need to be approved by the CBK before it is loaded onto loans.
The regulator further argues that the interbank rate is prone to volatility in periods of tight liquidity, and is also a backward looking rate in contrast with the forward looking CBR which also takes into account other economic indicators such as inflation, exchange rate and global developments.
“CBR is announced, in most cases every two months, which gives banks sufficient time to effectively effect changes in their lending rates,” added the CBK.
Kenya has gone through several rate-setting regimes in the last decade, which include the rate cap, which replaced KBRR in January 2017 and was in turn succeeded by the risk-based pricing model in 2019.
KBRR was computed as an average of the CBR and the two-month weighted moving average of the 91-day Treasury Bill rate and was reviewed every six months.
Some of the shortcomings in the KBRR included delayed transmission of changes in its components since it was reviewed every six months, and limited scope since it only covered flexible interest rate loans leaving out fixed interest rate loans and foreign currency loans.
The components of its premium were also loosely defined, resulting in a wide variance between the premiums among different banks.
The rate cap was repealed after it caused a slowdown in lending to the private sector due to banks being unable to price in risk, with smaller lenders also finding it hard to mobilise deposits under the law which has pegged lending and deposit rates within a four percentage point corridor of the CBR.
