Understand the Central Bank’s CBR and Its Effect on Your Money

The Central Bank of Kenya (CBK)’s Monetary Policy Committee (MPC) last week, On Tuesday, December 5, announced a 2% increase (200 basis points) in the Central Bank Rate (CBR) from 10.5% to 12.5%.  

This was the highest change in the CBR since July 2015 when the CBR was increased by 1.5% (150 basis points). The CBR is also at its highest level since July 2016. 

The CBR, or the base lending rate, is the percentage at which the CBK lends money to local banks. It is also used as a tool to stabilise the economy including managing inflation, increase flow of capital to boost employment, and stabilizing local currencies. 

For banks to optimise their operations, they often have to borrow from the Central Bank, usually in the form of short-term loans. This is then utilised in the form of credit extended to individuals and businesses. 

As such, Kenyan banks have over the past week been notifying their customers of a change in the interest charged on both existing and new loans. This trend has been across all banks and they have no control over this change since they are regulated by the CBK. 

In other words, the CBK as the regulator for banks, initiated a policy change through the CBR, to have the cost at which it lends to banks increased. Subsequently, banks have had a reciprocating change in the pricing of their financial offerings. 

Adjusting the CBR is a commonly used Monetary policy tool globally to either increase or decrease a currency’s supply. While changes to the CBR are done often, they are usually at a small scale - typically less than a percentage point (100 basis points). 

Why Did the CBK Increase the CBR? 

CBK Governor Kamau Thugge, who also chairs the MPC, noted that the decision to increase the CBR was made to cushion the Kenyan economy from the effects of the continued depreciation of the Kenya shilling against the dollar. 

“The MPC therefore concluded that there is a need to adjust the monetary policy stance to address the pressures on the exchange rate and mitigate second-round effects including from global prices. 

This will ensure that inflationary expectations remain anchored while setting inflation on a firm downward path towards the 5.0 percent mid-point of the target range. Therefore, the MPC decided to raise the Central Bank Rate (CBR) from 10.50 percent to 12.50 percent,” Thugge noted in a press statement. 

Indeed, the Kenyan shilling has been on a free-fall over the past few months and its continued weakness has had a significant impact on the cost of living and resulted in reduced economic activity. 

The weakened Kenyan shilling has discouraged investments that are denominated in the Kenyan shilling, which in turn results in reduced economic activity, unemployment, and a cycle of continued shilling depreciation. The depreciation of the shilling has also resulted in an increase in the prices of imported commodities including fuel, food products, cars, etc.

Increasing the CBR does two things which play into the CBK’s goal of taming inflation and protecting the shilling from further destabilisation: 

1. It makes the Kenyan shilling more attractive as an investment. By increasing the yield that individuals and businesses can earn from shilling-denominated investments, more people should be incentivized to buy the Kenya shillings. Greater demand for the shilling results in a stronger/stable shilling. 
2. Debt denominated in the Kenyan shilling becomes more expensive: This makes the cost of buying on credit more expensive and therefore slows economic activity, controlling inflation. 

If this happens, then the shilling will strengthen, and the prices of imported goods such as fuel will reduce. In turn, you will pay less for electricity, for your car, and the cost of living will ultimately reduce. 

How Has the Banking Industry Responded? 

Until 2019, the rate at which banks lend to customers is capped at 4% above the CBR. However, the cap has since been removed - with the CBK allowing banks to implement the risk-based pricing model which it approves. 

While banks have no control over the regulator’s policies, local banks have worked towards cushioning their customers from the increased CBR. 

Responsible lending 

Banks are obligated to practice responsible lending which involves ethical and prudent policies that make it possible for their customers to grow financially through the loans extended to them. 

Examples of how this is done in Kenya include: 

• Transparent terms and conditions
• Negotiations during repayments
• Fair interest rates
• Financial assessment to ensure capacity to repay 
• Disclosure of any material changes, such as when the interest rate is being adjusted

Risk-Based Lending 

The CBK has since March 2023 allowed banks to use the risk-based pricing model. Under this model, each bank is allowed to make adjustments in the pricing of its loan products. 

Those who would be traditionally locked out or disqualified from accessing credit get a custom rate that suits their financial situation. This has allowed more Kenyans to access relatively affordable credit products from the formal banking system. 

Financial Education

Several Kenyan banks have over the past year been proactive in offering free financial education to their customers as well as to Kenyans in general. Amidst the high cost of living, leading banks have held seminars and trainings to enhance financial literacy including budgeting tools, passive income opportunities, investment tools, etc.