Low interest rate regime in Kenya sets in

INTEREST RATES IN KENYA have turned South following the introduction of the Kenya Banks reference rate (KBRR). This is seen as the onset of a low lending rates regime in the country. KBRR is the weighted average of the Central Bank Rate and the two month the average weighted 91-T-bill rate. The T-Bill rate has served as the benchmark interest rate for many years. However, its declines have not resulted in relief for borrowers.

 The KBRR has done just that, stripped banks of the power to fix their base lending rates. And being a flexible rate determined by the Central Bank of Kenya, the regime of low interest rates has set in. Before KBRR, which came into force on July 8^th, the base lending rate which was determined by individual banks was above ten per cent pushing  the actual lending rate, in  some instances, was as high as 22 per cent.

 Now that era is gone and the days of huge profits by the banking industry will soon recede into a distant memory. The KBRR was set at 9.13 per cent and will remain in force until January. This means that the base lending rate for all banks will be 9.13 per cent and a mark- up. Therefore the new formula is KBRR+k where k is the mark-up. Following its introduction, lending rates have retreated from 22 per cent to about 15 per cent. This rate will remain in force until January 2015 when a new KBRR will be announced.

Standard Chartered, the first bank to adopt the new rates has pegged long-term mortgage rate at 9.13 +1.77 per cent. For individual borrowers, the rate was pegged at KBRR+5.77per cent bringing the maximum actual lending rate to 14.9 per cent.  Analysts expect a stampede to lower interest rates in the coming weeks.

Apart from lowering their rates, Banks are also required to reveal the components of costing of the rate. This will enable customers to compare the lending rate of various banks before they take out a loan. This empowers the customer to negotiate a lower borrowing rate.

Further since the rate will be reviewed every six months and one of its determinants is running average of the 91-day T bill rate, then further declines are expected. The rate is the government borrowing rate.  The government, being the largest borrower is keen to limit its forays into the local financial market. It has just borrowed some US$ 2 billion via a sovereign bond is looking at issuing other sovereign bonds to finance its development programme.

The law of demand and supply dictates that prices are lowered when supply increases. With the government out of the local credit market, the quantity of credit will increase leading to lower lending rates. The 91-T bill rate now stands at 9.273 per cent but can decline rapidly subject to low demand. At one time in the last decade the rate shrunk to as low as 1.5 per cent. If this rate shrinks, it will pull down the lending rates even if the CB rate remains at 8.5 percent.

 Another tool that can be used to drive down interest rates is the cash Ratio. This is a percentage of bank deposits that have to be deposited with the central Bank. When it is high, banks suffer a credit squeeze and since it does not earn any interest, the cost of the idle money is passed on to the borrower. In the late 1990s and early 2000s, this ration was as high as 12 per cent. It now stands at 8.30 per cent. The government has used this tool to ease credit squeeze by lowering it to as low 4 per cent in 2007/8.  It can be lowered again in order to lower lending rates.

Customer behavior will also push down the lending rates. Since the rate changes every six months, the expectation of a lower rate six months down the road could motivate some customer to withhold their demand for credit for six-months if the expectation is of a lower price.

 In the new environment, analysts say, the banking industry has to get used lending more at lower margins. In fact, experts say, lower lending rates are not a death sentence for banks. It