The proposed revision of the Kenya Banks Reference Rate formula offers renewed hope that interest rates may decline.
The KBRR was introduced by policymakers as a uniform base rate for all commercial lending.
It was expected to increase competition in the market because the transparent pricing would enable consumers to compare loan products.
The competition would lower the overall cost of loans to borrowers and expand access to credit.
The KBRR is computed as an average of the Central Bank Rate, which is the rate at which banks borrow from the Central Bank, and the two-month weighted moving average of the 91- day Treasury bill.
The idea was that all loans would be priced at KBRR plus a risk margin ‘k’, where ‘k’ would reflect the creditworthiness of the customer.
This means that in the life of a loan, ‘k’ remains constant, unless the loan is renegotiated or the creditworthiness of the customer changes.
Effectively, once ‘k’ is established for a particular loan, the lending rate would only be affected by a change in KBRR and not at the discretion of the bank.
KBRR would then be the tool by which the impact of changing market conditions and monetary policies would be transmitted to the credit market, through a revision by the Monetary Policy Committee every six months.
This gives borrowers some level of stability, because they would be concerned about a change of interest rates only twice a year.
Two years down the road, it is a matter of discussion whether KBRR is living to those expectations.
The undisputed verdict is that interest rates have not gone down significantly.
There is also the possibility that some banks may not be holding ‘k’ constant, without which the benefits of KBRR are lost.
Otherwise, on what basis would a bank announce a change in its lending rates for existing loans when it does not have the discretion to change KBRR?
On the other hand, KBRR is a technical formula, and for the MPC to hold it constant when the T-bill rate is rising sends the wrong message to the market.
The introduction of a third factor, the interbank interest rate, in the KBRR formula will make it more effective and realistic.
The interbank rate – the rate at which banks borrow from each other– is a significant pointer to the cost and level of credit in the market.
In fact, in the international market, the interbank rate is widely used as a base rate.
The over-reliance of KBRR on the T-bill rate means that government borrowing is having an inordinate influence on the cost of credit.
Revising the formula to dilute this influence renews hope for cheaper loans.
Karen Kandie is a financial & risk consultant and a PhD candidate in finance.