Why lending rates will not drop overnight


The Central Bank of Kenya (CBK)’s Monetary Policy Committee (MPC) recently lowered the benchmark Central Bank Rate (CBR) by 150 basis points, from 18 percent to 16.5 percent.

Following the decrease, a lot has been written and said in the media from seemingly knowledgeable writers and people about how banks are greedy and unwilling to reduce lending rates.

Barely three working days after CBK lowered the CBR there was an article titled “Unless Kenyan banks lower their greed, our economy is threatened.”Others articles have appeared elsewhere with opinions centred on this issue. However, what is missing in all articles is the whole truth and the actual facts.

The first fact is that banks actually have responded to CBK and have begun to lower their lending rates.

The truth is some banks lowered their rates even before the CBK decision. For example, both Victoria Commercial Bank and Kenya Commercial Bank (KCB) lowered their base lending rates, effective the beginning of July.

Other banks that have announced lower lending rates and base rate cuts include Prime Bank, Credit Bank, CfC Stanbic, Citibank, Barclays, Co-Operative Bank and Standard Chartered. And all this happened within the first two weeks of the MPC announcement.

The second fact is that not all banks increased their lending rates when the CBR was increased and therefore will not be likely lowering their lending rates. The rates were already priced low.

These banks decided to absorb the increased cost of funding due to increased rates they had to pay on their deposits. It should be expected that these banks may not reduce their rates at the moment just because the CBR is going down since they actually did not increase their rates in the first place.

So some perspective and history needs to be put in the debate so that people do not expect their mortgage payments to go down when in the first place the payments did not go up following the rise in the lending rates.

The third fact is that rates will not go down overnight like it happens with the fuel prices when the Energy Regulatory Commission announces a change in fuel prices.

The question is whether it was reasonable to expect that each and every bank would reduce their lending rates on the Friday following the MPC meeting on Thursday.

When the CBR falls, it signals to the market the direction and quantum of movement of all interest rates. The effect is that the market then starts pricing the funds (deposits) to the banks lower and the banks are then correspondingly able to pass on this to borrowers through reduced lending rates, hence the lag as the deposit rates do not react to signal instantaneously.

Some banks may however strategically take a view that since the deposit rates (cost of funds) can only move in a given direction following the fall in the CBR (i.e. downwards), they would move fast, initially at the expense of their margin but in order to capture the market share. This would then explain why some banks react immediately CBR goes down while some appear to take time.

Finally, with a current account deficit of 11.3 percent of GDP recorded in May 2012, I do not think we should be agitating for a rapid growth in credit at this time because it will end up choking growth even more. The economy is still very vulnerable.

We are likely to see a more rapid rise in inflation and depreciation of the exchange rates which will increase inflation further when people start using their loans to import goods. Just quoting lower inflation figures alone to justify arguments for a more rapid reduction in interest rates misses the point.

For lower interest rate to be sustained in the long term, the path to the lower rates must be comprehensive. While recognizing the important role that banks have to play in the process, all of us have a part to play including the government as well as the regulator.

The good news is that engagement has started between the Kenya Bankers Association and the various stakeholders, mainly CBK as well as the Judiciary to address the inefficiencies within the sector.

In addition, there has been progress through the Credit Information Sharing Initiative and soon banks will be sharing positive data with the overall goal of bringing down the credit risk (and loan costs).

(Dr Oduor heads the Centre for Research on Financial Markets and Policy at the Kenya Bankers Association)

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