Kenya is set to introduce a new reference lending rate for commercial banks in the next two months, in a move meant to bring down the cost of credit and boost private investment.

The formula for the new Kenya Banks Reference Rate (KBRR) is expected to reduce the weight government borrowing has in calculating the reference rate. A third parameter — the interbank rate — will be brought into the equation while the 91-day Treasury Bill rate will be retained.

This is expected to ease the cost of credit because the interbank rate is a better measure of how much money is in circulation, unlike government borrowing which usually reflects revenue deficits arising from poor collections or delayed remittances.

The interbank rate, which currently stands at 3.52 per cent, is the rate at which commercial banks lend to each other overnight to help out on overnight financial shortfalls in the clearing house.

“It is work in progress and this will be finalised in the next 1-2 months,” Joshua Oigara, chairman of Kenya Bankers Association (KBA) and chief executive of KCB, told The EastAfrican.

Analysts said the cost of borrowing would decline because the volatile impact of the 91-day Treasury Bill rate would be negated by the overnight rate.

“The cost of credit will come down slightly because the interbank is a much better indicator of the volume of cash in the market and what banks view as risks in terms of lending,” said Daniel Kuyoh, a senior investment analyst at Alpha Africa asset managers.

Currently, Kenya’s average lending rates stand at 18.3 per cent compared with Uganda’s (24.29 per cent), Tanzania’s (16.41 per cent), and Rwanda’s (17.6 per cent). The reference rate is at 9.87 per cent and the next review will be in June.

Central Bank Governor Patrick Njoroge signalled a review of the KBRR late last year after commercial banks said they were limited in how much they could lower interest rates under the existing formula.

“KBRR is not perfect. It needs to be improved and that work is going on. Following KBRR in its mechanical way would lead to instability. It would have a contrary policy on what we intend to do,” Dr Njoroge said in January when the bank refused to increase the rate in tandem with the Treasury Bill rate.

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KBRR has been in existence for 20 months but the instrument has proved ineffective in lowering interest rates and firming up the central bank’s strings on the economy. This has largely been blamed on volatility of the 91-day Treasury Bill rate — caused by government borrowing needs — which hinders a commercial bank’s long term view of risk.

Over the past three weeks, for instance, Kenya has borrowed $770 million from the domestic market in a bid to knock off its more expensive issuances that were taken late last year.

Data from the Central Bank (CBK) shows that the country’s domestic debt rose to $16.08 billion dollars between February 26 and mid this month, from its previous $15.31 billion at the start of the year. The Treasury’s overdraft at the CBK has also increased by $45 million over the same period.

In its Budget Policy Statement released last month, the Treasury revised down its domestic borrowing target to $1.7 billion from $2.2 billion.

Last week, Kenya’s National Treasury Cabinet secretary Henry Rotich said that only $390 million out of the $690 million requested by ministries had been approved for the supplementary budget covering expenditures to the end of June. There is also $510 million in bonds due in the next three months.

“We are in the final phase of drafting the supplementary spending plans for the fiscal year ending in June that introduce net cuts of $493 million. We have increased spending in areas such as security but these have been outweighed by cuts in net terms,” Mr Rotich said.

Raymond Kipchumba, an analyst at AIB Capital, however, said that before the election period, the government historically tends to amass its reserves.

“Here we see a trend where the government wants to increase its liquidity in order to meet its huge spending needs. Then we are also seeing maturities due within the next three months to the end of the financial year, which means that they have to borrow to repay these debts,” said Mr Kipchumba.

Investors are also rushing to lock in higher rates as the yields on the government securities continue trending down due to high liquidity in the money markets and the revised borrowing target. The government is also staring at maturities of several bonds before the end of this financial year worth $510 million.

Mr Kuyoh said the government had started building reserves for the redemptions so as not destabilise the market when the bonds fall due between now and May.
According to Mr Nalwenge, the net domestic borrowing has increased in the past three months with the government collecting averagely $220 million through the weekly papers.

“However, compared with last year, this is low because in the third quarter of 2015, the average rate of collection was at $450 million as the government had to collect more money to tame inflation and the weakening currency,” he said.

The rate of growth of the debt is, however, likely to slow down after the redemptions in view of the new target and minimal pressures for domestic debt. Reduced government borrowing would further help reduce the interest rates as the KBRR would be reviewed with the lower T-Bill rates in mind.

The current KBRR is an average of the CBR and the two-month weighted moving average of the 91-day Treasury bill rate. KBRR acts a uniform base rate for all banks, meaning that a customer is charged a variable above the rate to accommodate a bank’s overheads and a borrower’s risk profile.

KBRR was introduced in July 2014 to ensure transparency in pricing of loan products.

At its introduction the rate was set at 9.13 per cent. It was reviewed in January 2015 to 8.54 per cent and further reviewed in June 2015 to 9.87 per cent. The rate was retained at 9.87 per cent in January despite movements in the factors suggesting it should have increased to 10.78 per cent.

According to the National Treasury the upward revision of KBRR from 8.54 per cent in January 2015 to 9.87 per cent in June 2015, led to an increase in the average lending rates to 17.4 per cent in December 2015 from 16 per cent in December 2014.

Similarly, deposit rates increased to 7.9 per cent from 6.8 per cent over the same period leading to an increase in interest rate spread to 9.5 per cent in December 2015 from 9.2 per cent in December 2014.