Kenya’s commercial lending rates fell to a three-year low last month, with bankers projecting a further decline in coming months.

Data from both the Central Bank of Kenya (CBK) and the Kenya National Bureau of Statistics (KNBS) show average lending rates hit 16.49 per cent last month — a rate last seen in June 2011— on the back of easing inflationary pressure, increased competition in the loans market and growth in the economy. 

A continued decline in the yields on Treasury securities with the expected issuance of a Eurobond is further pushing down the cost of funds.

READ: First $2bn Eurobond set to push down lending rates

The latest market perceptions survey by CBK shows borrowers in small banks continue to shoulder a high burden due to the relatively higher rates charged by these lenders compared with their larger counterparts.

Large banks, said the CBK survey, expect comparably lower average lending rates in the remainder of 2014 due to a comparatively lower cost of funds while small banks expect comparably higher lending rates due to a higher cost of funds.

Executives in large banks expect lending rates to fall to 14.10 per cent in the coming months while those in medium-sized banks are projecting a drop to 16.39 per cent.

Comparatively, their smaller counterparts see lending rates rising to 17.31 per cent, a signal they are feeling the pinch of costly funds. This has pushed the average rates expectations from the overall banking sector to 16.48 per cent, lower than  the 16.56 per cent projected in February, the last time such a survey was done.

“But cost of funds and increase in demand for loans to finance investments with the pick-up in economic activity could exert some pressure on interest rates to rise,” said CBK Governor Njuguna Ndung’u.

The drop in interest rates could put further pressure on small and middle level banks given that it squeezes their profit margins.

Whereas the larger banks — KCB, Equity, Barclays, Co-operative, Standard Chartered and CFC — are able to attract and mobilise cheap deposits, smaller banks must offer attractive rates to attract depositors.

While the average interest rate charged by the banking industry is 16.48 per cent, big banks, middle-sized banks — National Bank, NIC, CBA — and small banks — like Jamii Bora and Fina Bank — charge an average base rate of 14, 16.39 and 17.31 per cent. Microfinance institutions, the majority which struggle to attract deposits, are charging about 19 per cent as their base rate.

Wide gap

Such a fall in lending rates would widen the gap that Kenyan lenders have opened over their East African counterparts. Kenya is by far the cheapest country in the region to take up a bank loan.

Borrowers in Uganda are currently paying nearly 22 per cent interest on loans, Rwanda and Burundi 20 per cent and Tanzania 21 per cent.

Last month, Kenya’s inflation stood at 6.4 per cent, down from a high of 20 per cent in 2012.

The falling cost of deposits has helped pull down the average lending rates, with banks gradually retiring the expense deposits contracted over the past three years. 

Kenyan banks listed the cost of funds as the key determinant of their interest spread— the difference between the borrowing and lending rates— and consequently their lending rates.

“... Banks perceive cost of funds, credit risk, liquidity risk, Treasury-bill rates and the Central Bank Rate as being among the most significant determinants of interest rates spreads,” said the CBK survey.

Banks expect the 12-month overall inflation to average 6.37 per cent in the next two months while MFIs and non-bank private firms expect an average of 6.40 per cent and 6.21 per cent respectively.

“The decline in inflation expectations in the remainder of 2014 was attributed to stability in food and fuel prices; monetary policy measures in place; and a stable exchange rate,” said the CBK survey.

“However, the main risks to the inflation outlook were cited as uncertainty on the onset of the long rains, volatile international oil prices; and expected increase in demand with pick-up in economic activity.”

The CBK surveyed all commercial banks in Kenya,  all MFIs and at least 100 non-bank private sector firms.

READ: Reprieve? CBK team to probe high interest rates

The drop in interest rates comes even as both the Competition Authority of Kenya and the CBK — which formed a joint committee with Treasury — to investigate the cause of the relatively high lending rates in the country.

Kenya has the highest interest spread — about 11 per cent, compared with 3 per cent in Tanzania — a level that the government sees as unsustainable.

But the main contention has been that given that the top five banks in Kenya control 60 per cent of loans and deposits — most of them  cheaply obtained — the interest charged on loans ought to be lower.

“We must explore ways of bringing lending rates down to single digits,” said William Ruto, the country’s Deputy President.

Raised CBR

Kenya’s interest rates rose in late 2011 following a decision by the CBK to raise the Central Bank Rate (CBR) — the rate at which the central bank lends to commercial banks — to a high of 18 per cent as it sought to stem a spike in inflation, which had hit 20 per cent and stop the depreciation of the country’s currency.

The CBR has since dropped to 8.5 per cent while the overall month-on-month inflation increased slightly from 6.27 per cent in March to 6.41 per cent in April.

READ: Central banks project inflationary pressure in Kenya and Uganda

The drop in interest rates will come as a relief for a government looking at kick-starting the economy which last year expanded by only 4.7 per cent, well off the government target of 6 per cent and the World Bank estimate of 5.5 per cent.

The subdued economy coupled with election jitters in 2013 as well as delayed payment of suppliers led to a rise in non-performing loans (NPLs) as companies struggled to repay loans.

“Indeed, some of the NPLs could be linked to the period when the markets were unstable, which necessitated monetary policy tightening and the attendant increase in the cost of credit... The declining rates can be expected to correlate with a decline in NPLs,” said Jared Osoro, the Director of research and policy at the Kenya Bankers Association.

The drop is expected to accelerate private sector borrowing, helping to stroke the much needed demand for goods and service and thus get the economy back on track.