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Expensive loans beckon as tight cash hits banks

new kenya currency

A man holds the new Kenyan banknotes in circulation on June 28, 2019, in Nairobi. The cost of borrowing between commercial banks has jumped to a high of three-and-a-half years amid increased demand for credit, indicating a fresh surge in loan prices amid tightened cash supply in the banking system.

Photo credit: Simon Maina | AFP

The cost of borrowing between commercial banks has jumped to a high of three-and-a-half years amid increased demand for credit, indicating a fresh surge in loan prices amid tightened cash supply in the banking system.

The interbank rate, the interest charged on short-term loans between banks, stood at 7.16 per cent on March 22, data from the Central Bank of Kenya (CBK) shows, the highest since 7.36 per cent recorded on October 22, 2019.

An increase in interbank rate is attributable to a decline in liquidity in the sector due to strong loan growth which means banks have less liquidity on their balance sheets, resulting in higher rates.

Traditionally, an increase in interbank rates leads to higher funding costs for banks, which in turn leads to higher lending rates for borrowers.

Risk profile

This jump in the interbank rate come as more banks shifted to dishing loans which are priced based on the risk profile of customers.

So far, the CBK has allowed 24 of Kenya’s 39 banks to increase their lending rates based on the borrower’s risk profiles with the majority of the approved lenders being smaller outfits including Credit Bank and Victoria Commercial Bank.

Nairobi Securities Exchange-listed, Stanbic Bank also extended at least Sh1 billion in loans priced based on the risk profile of customers between October and December 2022, after the CBK granted it a nod to implement the model at the start of the fourth quarter.

“There is evidence of an increase in the short-term interbank interest rates, that is expected to be followed by an increase in the longer-term interest rates,” stated Kenya Bankers Association in their recent Research Note published in January.

“This has been supported by the considerable progress of the market in transitioning to risk-based credit pricing regime, that allows banks to price loans in line with the evolution of risk and policy signals.”

There has been an expanding demand for credit, especially from households and businesses.

CBK’s data show growth in private sector credit increased to 12.5 per cent in 2022 compared to 8.6 per cent in 2021.

Strong credit growth was observed in sectors including manufacturing (13.8 per cent), transport and communication (23.5 per cent), trade (11.4 per cent), business services (13.7 per cent), and consumer durables (12.9 per cent).

In the week ending March 16, the daily average number of deals of borrowings by banks from their peers was 36 up from 28 in the previous week ended March 9.

The average value of loans daily was Sh17.92 billion at a daily average interbank rate of 6.82 per cent from Sh17.34 billion.