The puzzling Kenyan Banking (Amendment) Bill 2015

“A bank or financial institution shall set the:

  • Maximum interest rate chargeable for a credit facility in Kenya at no more than four per cent, the base rate set and published by the Central Bank of Kenya and
  • Minimum interest rate granted on a deposit held in interest earning in Kenya to at least seventy per cent, the base rate set and published by the Central Bank of Kenya.”

This extract from the Banking (Amendment) Bill 2015 has left room for a lot of interpretation stemming from the unclear reference of the base rate to be used and whether the amendment affects the Annual Percentage Rate (APR) or the interest rate component used to compute the Total Cost of Capital (TCC).

Key Definitions

Kenya Bank’s Reference Rate (KBRR) is computed as an average of the Central Bank Rate (CBR) and the two month weighted moving average of the 91-Day Treasury bill rate. The KBRR was introduced as a uniform base lending rate across the banking sector in the year 2014. It enables consumers compare the pricing of bank interest rates. This rate is reviewed every six months. The current KBRR stands at 8.90% and was last reviewed on 25th July 2016 meaning that the next review should be sometime in January 2017.

The Central Bank Rate (CBR) is the benchmark rate for monetary policy and it is the lowest interest rate that the Central Bank charges on loans to banks. It is reviewed at least every two months and its movement signals the monetary policy stance. The current CBR stands at 10.50% and was last reviewed on 09th September 2016 meaning that the next review should be sometime in November 2016.

Brief Background

Mid 2014, Kenyan banks adopted the Annual Percentage Rate (APR) pricing mechanism which is a standard pricing approach that promotes greater transparency and borrower protection allowing borrowers to compare the interest rates for different banks. The significance of which base rate to use for bank loans comes in at the computation of the Total Cost of Credit (TCC) which has an interest rate component. The interest rate component in the Total Cost of Credit (TCC) is derived from the KBRR.

The computation is well broken down by the Kenya Bankers Association (KBA) below:

tcc-and-apr

How lending rates are set

Banks earn a spread on the money they lend out from the money they take in as deposits which is seen on the net interest rate margin (the difference between what they earn on loans versus what they pay out as interest on deposits).

Banks in Kenya have been charging ridiculously high lending rates taking into account competition, risk factors, costs and the CBK policies. The CBK influences interest rates by setting certain rate such as the CBR, stipulating the bank reserve requirements and in the buying and selling of Treasury Bills which affect the deposits that banks hold at the CBK. This is known as monetary policy which keeps in check the health of the banking system and as such the overall health of the Kenyan economy. One of the main ways the CBK influences monetary policy is through the CBR which is a component of the KBRR.

More goes into setting the lending rate and the above is just a brief.

Ways in which you can interpret the Bill

What this means is that there is a cap on the interest rate charged on loans and a minimum rate of interest on deposits held. Again, this could be interpreted as in direct reference to the interest rate component as opposed to the Annual Percentage Rate (APR) which leaves room to interpret it as the interest rate component in the Total Cost of Capital (TCC).

Again, the bill makes reference to banks or financial institutions disclosing all the charges and terms relating to the loan. One can interpret this as saying that over and above the capped interest rate the banks must disclose the other components that are used in computing the Total Cost of Capital (TCC) as shown in the breakdown (diagram) by the KBA.

Based on the base rate, if you think the KBRR makes sense because it features in all the computations for the lending rate and is also the benchmark rate for pricing all floating/variable/flexible interest rates on all Kenyan Shilling denominated loans or credit facilities also note that the CBR is a component of the KBRR which then makes the KBRR a factor of the monetary and economic environment.

Parting Shot

Tomorrow, Wednesday 14th September 2016, is the date that we should expect more clarity on the above issues. At present, we can only speculate as most banks have considered the base rate as the CBR while CBA (being the lone wolf) has considered the base rate as the KBRR. Which bank/(s) are right? Only time will tell.

PS: Equity Bank has been ‘hush hush’ about the whole interest rate fiasco. Is the bank being cautious or do they have something up their sleeve? Only tomorrow will reveal their strategy.

 

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