CBK regains control of monetary policy after Uhuru signs repeal of interest law

Sunday November 10 2019

Central Bank of Kenya (CBK) headquarters in Nairobi.

Central Bank of Kenya (CBK) headquarters in Nairobi. Banks avoided lending to the private sector particularly to micro, small and medium-sized enterprises whom they consider high risk borrowers and instead channelled their funds to risk-free government securities in the rate cap era. PHOTO | SALATON NJAU | NMG 

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The repeal of interest rate caps has restored the Central Bank of Kenya’s control over monetary policy, ending nearly three years of a lame duck regulator.

Kenya this week abolished control on the cost of loans after Parliament failed to raise the required two-thirds majority or 233 lawmakers to overturn President Uhuru Kenyatta’s memorandum on the removal of a controlled interest rate regime, paving the way for the Central Bank to apply its policy rate in controlling inflation, money supply and the exchange rate.

The regulator uses the Central Bank Rate (CBR) as a key tool for signalling its monetary policy direction, ordinarily lowering the CBR to increase liquidity in the economy and raising it to tame inflation or strengthen the exchange rate.

The inclusion of CBR in the formula for determining cost of loans, however, left CBK hamstrung, blunting its ability to alter cost of loans without hurting the wider economy through change in the price of credit.

The Central Bank of Kenya (CBK) had publicly stated that the rate caps had rendered its monetary policy tools ineffective, making it difficult to control inflation and the amount of money in circulation.

The World Bank had also stated that interest rate caps undermined monetary policy transmission and implementation, with implications for CBK’s independence and its ability to steer the economy.


“With caps linked to the CBR (policy rate), changes in the policy rates could be counterproductive. Furthermore, pegging the interest rate cap to the CBR has fundamentally affected the effectiveness of monetary policy, and the signalling and relevance of the CBR,” said WB.

The law on interest rates came into force in September 2016, capping lending rates at four percentage points above the prevailing Central Bank Rate.

The repeal is a big win for commercial banks, the CBK and international financial institutions such as the IMF and the World Bank which have all been pushing for the removal of rates caps arguing that the law had failed to achieve its purpose of freeing affordable credit to the private sector.

Nairobi Securities Exchange listed commercial banks recorded a sharp increase in their share prices when it became clear that the law would be changed, gaining Ksh38 billion ($368 million) market value in one day.

Assuaging fears

The stock rally, however, lost steam towards end of the week, with more than half of the 11 listed banks recoding price declines on Thursday, November 7, when President Uhuru Kenyatta signed into law the Finance Bill 2019.

The Finance Act 2019 repealed section 33b of the Banking Act that provides for the capping of interest rates.

Analysts at Kenya’s Standard Investment Bank said investor excitement on banking stocks has cooled down.

“Market enthusiasm around bank stocks seems to have scaled down with the exception of Diamond Trust Bank and Stanbic Holdings,” said SIB in a note to investors.

Nairobi Securities Exchange data showed that Equity Bank’s stock declined three per cent to Ksh 48.75 ($0.48) per share on reduced demand for the counter while that of KCB slid 0.9 per cent to Ksh 52.75 ($0.52).

Barclays lost 2.25 per cent to Ksh13.05, I & M Bank declined 4.29 per cent to Ksh50.25 ($0.5) while NIC group stock fell 3.78 per cent to Ksh36.90 ($0.36).

Co-operative Bank’s share fell 0.94 per cent to Ksh15.85 ($0.15) while the overall equities turnover dropped 72.3 per cent to $8.6 million on reduced trading of Safaricom and banking stocks.

Mortgage lender Housing Finance, Bank of Kigali Group and National Bank stocks remained unchanged at Ksh7.34 ($0.07), Ksh28 ($0.28) and Ksh4.12 ($0.04) respectively.

Borrowers fear that the removal of the rate cap now sets the stage for the return of expensive loans that had risen to more than 25 per cent before the rate cap, with commercial banks free to price their loans at will.

“As an industry, we are in a new equilibrium. Banks have reached a new business model. We lend to current customers at 13 per cent because we have accepted their risk profile as an industry. That will not change the next day.

“So the fear that there will be a massive repricing the next day is not true,” said KCB chief executive Joshua Oigara, who is also chairman of the Kenya Bankers Association, in a statement intended to assuage borrowers’ fears.

Banks avoided lending to the private sector particularly to micro, small and medium-sized enterprises whom they consider high risk borrowers and instead channelled their funds to risk-free government securities in the rate cap era.

Last year, the Parliamentary Budget Office proposed a review of the regulations governing capping of interest rates in a bid to boost lending.

“The interest rate controls, which are legally anchored to the CBR by design, have affected the flexibility of the key monetary policy tool, the CBR itself,” stated the Budget Office report for the 2018/2019 fiscal year.

“This law may require further streamlining to ensure that the profitability of banks is not compromised and to improve monetary policy flexibility. A review of the interest rate regulation framework should ensure that the design of any controls is completely delinked from the CBR, which is essentially a monetary policy rate of the CBK,” it added.