The Central Bank of Kenya’s surprise move to raise base lending rates to 10.5 per cent has set the stage for high interest regime that has forced the government to pay over 12 per cent interest for a three-month debt.
The decision to raise the central bank rate by a percentage point during an unscheduled monetary policy committee meeting on June 26 has pushed the interest rate on the government’s benchmark debt facility to levels last seen in November 2015.
Average interest on the benchmark 91-day Treasury bills during last week’s sale hit 12.11 per cent, the highest since November 2015 when it averaged 12.34 per cent.
The last time the interest rate on the 91-day government paper hit such levels, it ushered in a loan pricing regime where banks raised borrowing costs for businesses and households to high rates which prompted lawmakers to cap what they charge.
The late June’s hike on the base interest rate was aimed at reining in the stubbornly rising inflation which had defied earlier CBK’s projection for a slowdown in the month.
Analysts say the move was an attempt by the new CBK governor Kamau Thugge to establish his inflation-battling credentials.
Increasing the key lending rate makes borrowing more expensive as banks use the rate as a base onto, which they load their margins when pricing loans.
The growth in benchmark central bank rate, technically known as [monetary] policy tightening, is expected to make cost of getting money more expensive. This usually prompts consumers to cut or postpone expenditure on luxurious goods such as cars, thus helping rein in elevated inflationary pressures from the demand side.
Banks largely use the central bank rate as a base that is normally the cost of funds, plus a margin and a risk premium, to determine how much they charge a particular customer seeking credit.
And the markets have started feeling the impact of the tightening, which kicked off May last year, with investors demanding higher returns to lend to the government.
The CBK, the government’s fiscal agent, last Thursday accepted bids worth Sh33.27 billion for 91-day T-bills from investors who demanded interest of 12.11 per cent on average. This was over eight folds more than what the CBK offered. The investors, however, largely kept away from six- and 12-month government debt facilities whose uptake was a measly 13.47 per cent and 17.74 per cent, respectively, of the Sh10 billion offered for each securities.
Investors’ demand for shorter-dated securities and the preference for risk-adjusted returns have driven yields higher as they shun longer-dated instruments such as Treasury bonds as cover from duration risks in an uncertain interest rate environment.
Investors have been demanding higher margins to hold government securities as they factor in the effects of rising inflation on returns at a time when Kenya is looking to mop up funds from the domestic market after being locked out from external financing by exorbitant interest rates.
Earlier last week, the CBK had to accept yields of 16.844 per cent on a new bond with a tenure of just five years.
“T-Bills are expected to keep climbing in the near term as they [investors] continue pricing in the evolving macro-economic risks,” Wesley Manambo, a research analyst at Nairobi-based Genghis Capital, told the Nation via email.
“With regards to lending, the rising CBR rate is the elephant in the room as it will see a direct adjustment in loan pricing. That said, the rising T-Bill rates may put additional pressure on the risk based lending landscape since it's an indication of a rise in the overall risk levels in the economy - more so for risks such as liquidity risk.”
With commercial lenders pricing their loans using the 91-day T-bill rate as the reference rate, which is widely regarded as the risk-free rate, and onto which they add their margins, business and families can expect to pay a higher premium to access funds from banks.
A number of top-tier lenders, notably Equity and NCBA, have already notified customers that there base lending rates, which rises in line with assessed risk profile of individual borrowers, will rise from August, citing the increased CBR rate.
The current CBR rate of 10.5 percent was last seen in July 2016, two months before the populist Banking (Amendment) Act, 2016 on September 14, 2016 setting the maximum interest banks charge customers and minimum interest they pay on fixed-term deposits.
The law, which was repealed November 2019 after curtailing lending to small traders, had capped lending rate at four percent above the CBR rate and minimum interest on deposit accounts at 70 percent of the same key rate.
Prior to the prevailing CBR rate, the previous increase in cost of loans was yet to dent private sector credit growth as the business and household needs including working capital outpace price concerns.
Private sector credit growth, for instance, had stuck above 10 percent since March last year and closed the month of April at an annualized growth rate of 13.2 percent.
“The rising [T-bill] rates bring about the risk of crowding out of the private sector as banks find government securities to be more attractive,” Mr Manambo said. “In as much as perpetual demand for money is at play for private sector players, this may upshot in credit crunch for some players who fund operations on a skewed equity debt mix as access to loans becomes constrained and expensive.”
The World Bank has cautioned against persistent crowding out of the private sector due to heavy domestic borrowing by the Treasury.
The multilateral lender noted commercial banks had failed to reach their peak support for investments as the government provided the easy way out by borrowing heavily from the domestic credit market.
“Credit is growing more slowly than GDP, highlighting that the banks’ role in facilitating investments and economic activity remains challenged,” the World Bank wrote in the latest report on Kenya.
The CBK has approved the risk-based credit pricing mechanism, which could potentially hand banks the window to further raise interest margins.
Risk-based credit pricing is bound by the Banking Sector Charter which laid down the foundation for the scrapping of interest rate caps in 2019 by fostering fairness in credit pricing.
Dr Thugge hinted during a press conference that the CBK will not hesitate to raise the CBR rate in the event of further upside inflation surprises like June’s.
“It was critical that we take action to address this change in inflationary expectations and hopefully anchor those expectations so that people don’t make decisions on the basis of expecting inflation to fall,” the CBK boss said on June 27, explaining his decision. “We have looked at the impact arising from the Finance Bill (Act). The action that we have taken to raise the CBR rate is actually to address any potential impact those measures might have on inflation.”
