Why CBK, banks are fighting over cheaper credit

Banks are pushing for a further cut in the Central Bank’s benchmark lending rate at its meeting Tuesday, arguing that low inflation and a stable Shilling provide room to stimulate sluggish private sector credit growth.

In a research note, the Kenya Bankers Association (KBA), the industry lobby, said the Central Bank of Kenya’s (CBK) Monetary Policy Committee (MPC) should lower the Central Bank Rate (CBR) from its current 9.50 per cent when it meets today to enable banks to lend cheaply. 

“The need to stimulate credit growth to support economic activity becomes paramount,” the KBA’s Centre for Research on Financial Markets and Policy said.

“We view that there is scope to further ease monetary policy via a cut in the Central Bank Rate.”

The call comes as commercial banks face scrutiny for their slow pace in passing on the benefits of previous rate cuts to borrowers, a practice that has drawn criticism from businesses and regulators.

CBK will hold its Monetary Policy Meeting today amid renewed concerns about the rising cost of essential commodities and stagnation in lending to the private sector, which has ignited fears about the slowing economy. 

The cost of living measure - inflation rose to 4.6 per cent year-on-year in September, up from 4.5 per cent in August, according to the Kenya National Bureau of Statistics (KNBS).

The increase was mainly driven by a rise in prices of food and non-alcoholic drinks (8.4 per cent), transport (four per cent), and housing, water, electricity, gas and other fuels (1.4 per cent), the bureau said.

CBK has cut its benchmark rate seven times since last year, including a 25-basis-point reduction in mid-August this year. Despite this easing cycle, lending rates have remained high for many businesses, stifling borrowing.

Data from the lobby shows private sector credit growth was a modest 3.3 per cent in August, far below levels considered supportive of robust economic expansion. This comes as the ratio of non-performing loans (NPLs) has risen to 17.6 per cent in June.

The rise in bad loans indicates a substantial portion of Kenyan borrowers are struggling and increasingly failing to meet their loan repayment obligations, reflecting the harsh economic realities and pressures faced by households and businesses alike. 

The KBA cited several factors supporting a rate cut, including overall inflation of 4.6 per cent in September, which remains within the government’s target range. Core inflation, which strips out volatile food and fuel prices, eased slightly to 2.9 per cent. 

The shilling has also held steady against the US dollar, supported by ample foreign exchange reserves and resilient remittances. KBA reckons the recent rate cut by the US Federal Reserve has also created a “more favourable interest rate differential.”

The research note concluded that with inflation expectations anchored and the exchange rate remaining stable, a cautious easing of monetary policy is warranted to provide impetus for stronger credit growth and anchor economic growth, which recorded a five per cent growth in the second quarter but faces downside risks from weak demand.

The clamour by the banks comes at a time when the CBK is implementing a new loan pricing system that has changed how borrowers pay interest on loans, in a significant move to make lending by commercial banks more transparent and responsive.

The MPC’s decision, expected Tuesday afternoon, will reveal how CBK weighs these competing pressures of stimulating growth versus safeguarding macroeconomic stability.

For years, many Kenyans have struggled to understand why their loan costs remained high even when the Central Bank reduced its benchmark lending rate, long used to determine the pricing of loans and other financial products.

The new reform aims to address that opacity while creating a fairer, more competitive lending environment. Under the new rules, borrowers with strong credit histories—those who consistently repay loans on time—are likely to receive lower premiums or costs for loans.

Conversely, those with riskier profiles may pay more. This rewards financial responsibility while encouraging others to improve their creditworthiness. The revised Risk-Based Credit Pricing Model (RBCPM) for the banking sector took effect from September 1 this year.

Monetary policy

The CBK says the “objective of the revised RBCPM is to strengthen monetary policy transmission, enhance transparency in lending, and promote responsible lending by aligning credit pricing with the borrowers’ risk profiles.”

Think of the new loan pricing system like a taxi ride with a hailing app. Previously, loan pricing was like agreeing on a fixed fare that didn’t always reflect the actual cost of the journey. Now, your loan interest will be calculated using a transparent formula.

The total lending rate will be made up of a base rate referred to as the Kenya Shilling Overnight Interbank Average (Kesonia) plus a Premium referred to as (“K”).

The total cost of credit also includes fees and charges.

Kesonia is like the base fare on a taxi app. It represents the daily rate at which banks lend to each other.

The CBK notes that Kesonia “is a transaction-based benchmark rate reflecting the average interest rate at which banks in Kenya lend and borrow unsecured overnight funds in Kenyan Shillings” and is “designed to serve as Kenya’s near risk-free reference rate.”

Just as traffic conditions can change the cost of a ride, economic conditions will cause this rate to move up or down daily.

On the other hand, Premium (“K”) is like the additional charges on your taxi ride. It covers the bank’s operational costs, its return to shareholders, and a charge based on your personal risk profile as a borrower (a risky route might cost more).

Responsible borrowers with good credit histories may see lower premiums.

Fees and charges are like extra charges for toll roads or extra stops. They include loan origination, arrangement, and late payment fees. These charges must now be clearly disclosed to customers and the public.

The CBK says these fees “may include loan origination, arrangement, commitment, default, and late payment fees, which are charged separately and must be disclosed to the customers and CBK.”

“The final revised RBCPM is anchored on the overnight interbank average rate, now renamed the Kenya Shilling Overnight Interbank Average to align it to the international best practices,” said CBK.

The new system means greater transparency for borrowers. For the first time, banks will be required to publicly break down their loan pricing. Each lender must publish its average rates, premiums, and fees on its website and the CBK’s Total Cost of Credit portal.

The CBK specifies that all banks will “on a monthly basis, publish their weighted average lending rates, and weighted average premium (‘K’), all fees and charges for all their lending products, and Annual Percentage Rate (APR) on the total cost of credit website.” 

The new system is designed to ensure that when the CBK adjusts its policy rate, commercial banks reflect these changes more quickly in their lending rates. This is what’s known as monetary policy transmission, a process that makes the central bank’s actions more effective.

The report states this new model “enables immediate transmission of monetary policy to the real sector through adjustments in bank interest rates and responds in real time to changes in market conditions.”

Pricing model

This means borrowers could benefit sooner when rates fall, but may also face increases sooner when rates rise. 

To prevent banks from setting unfairly high premiums, the CBK will review each bank’s pricing model. This ensures that the premiums charged are justified and based on actual costs and risks. CBK says it “will review each bank’s model, policies and procedures, post implementation as part of its surveillance process.” 

While the new model promotes fairness, it also introduces greater variability for borrowers with variable-rate loans. Since Kesonia changes daily, monthly repayments could become less predictable. Borrowers who prefer stability may want to consider fixed-rate loans, which are unaffected by these changes.

The CBK clarified that the new model “will apply to all variable rate loans except for foreign currency-denominated loans, whose pricing is primarily influenced by external factors such as currency risk, and fixed rate loans.” 

The new rules cover all new variable-rate loans. Existing variable-rate loans will transition to the new system by February 28, 2026.

The CBK’s overhaul marks a new step toward a more transparent and efficient lending system.