KBA Statement On Risk Based Credit Pricing Model Review By CBK

The Kenya Bankers Association (KBA) takes note of the Central Bank of Kenya's (CBK) publication of a consultative paper on the review of the risk-based credit pricing model, published on 23rd April 2025 for comments by commercial banks and the general public. The initiative aims at addressing persistent challenges in the credit market, including perceived high lending rates and lack of transparency in pricing.

CBK proposes the adoption of a single unified base rate—the Central Bank Rate—as the common reference rate for determining lending rates in the Kenyan banking sector. The CBK proposal envisions lending rates to be determined by adding a premium ("K") to the CBR. The premium 'K' shall comprise the bank's operating costs related to lending, return to shareholders, and the borrower's risk premium. The CBK proposes to review each bank's proposed premium 'K' before it is rolled out. This means that the base rate and the premium 'K' would effectively be determined by CBK.

To the contrary, KBA, in proposing a unified base rate, considered the merits of using the market-driven interbank rate over the CBR and allowing the premium 'K' to be fully flexible. The rationale for KBA's proposal is underpinned by the following factors:

(i) Global best practice shows that market base rates are derived from short-term market rates. Global examples of base rates, such as SOFR, SONIA, EURIBOR, and even the defunct LIBOR, are all typically derived from short-term market-determined funding rates for banks and serve as the foundation of pricing various financial instruments in the markets they are adopted.

(ii) Previous efforts towards a unified base rate (in the Kenya Banks Reference Rate) did not benefit from a supportive monetary policy framework that requires CBK to activate the transmission of policy action. The suspended Kenya Banks Reference Rate (KBRR) failed to deliver the desirable results because its design did not benefit from CBK actively operationalizing its policy decisions. The CBK, in August 2023, announced a market transition towards focusing on the interbank market and the implementation of an interest rate corridor. The new monetary policy framework activates the transmission of monetary policy via the interbank market. In fact, the new framework recognizes the interbank rate as the operational target. The interest rate corridor framework ensures that once the CBK takes a policy decision—typically communicated in changes in the CBR—CBK liquidity operations would have to be undertaken to actively influence market liquidity so as to align the interbank rate with the CBR (now with allowable deviation of 75 basis points on either side). The new framework enhances the banking industry's confidence that the interbank market (aligned to the CBR) would be the best anchor for the transmission of monetary policy signals. There would be a weak transmission of policy signals if the CBR is not operationalized via liquidity injections/withdrawals; thereby rendering the policy rate not effective in influencing market lending rates.

(iii) Flexibility on the premium 'K' is consistent with the law that recognizes a liberalized interest rates regime in Kenya. Beyond the base rate, 'K' should be allowed to be fully flexible across banks banks, products and clients based on each bank's differentiated cost of funds, operational costs, shareholder's expected return on investment and customer's risk premium. The flexibility would ensure that the pricing model is consistent with the legally-backed market-driven interest rate policy regime in Kenya and that all customers including those with very high credit risk levels (such as the low-income individuals and small businesses) are supplied with loans to finance their activities at interest rates commensurate with their risk profiles This would ensure that no customer is shunned away by lenders because of their high-risk levels but a bank is able to price their loans appropriately as they financially include the customer while adhering fully to risk-based pricing principles;

(iv) Typically, base rates are not applied to all loans but mainly to flexible rate loans. KBA proposed that the new pricing framework would apply only to local currency flexible rate loans exceeding 12 months in maturity, and should exclude such negotiated loans, digital loans, and credit card loans These loans are designed uniquely and are governed by specific contracts agreed upon between the borrower and the lender,

(v) The transition period must consider the cost of transition and the infrastructural requirements. KBA proposed to implement the new framework on a trial basis over 6 months and full implementation over an additional 6 months to allow ample time for reviews on negotiated loans (on review dates) backed by legally binding contracts and upgrades of core banking systems to accommodate the new lending framework

KBA has reviewed the CBK paper that proposes the adoption of the CBR as the base rate and takes note of the following

i. The CBK is silent on the interbank market corridor as the monetary policy implementation framework This raises a concern whether the CBK has abandoned the interest rate corridor framework and whether the market still need to consider the interbank rate as the operational target for monetary policy. Ignoring the interbank rate sets the market back to the pre-August 2023 challenges of CBR being misaligned with market conditions and therefore weaker transmission of policy;

ii. The CBK requires banks to submit their proposed premium 'K' for CBK's review and noting prior to rolling out While CBK has not published the criteria for "reviewing and noting'. With a unified base rate and without clarity on the criteria for reviewing the proposed 'K', there is a risk that the new framework is conceived as an attempt to control interest rates. In addition, premium 'K' would differ from one client to another for both existing and potential clients. it is impractical to submit to CBK the premium 'K' for all clients;

iii. The CBK, in arguing against the interbank rate, indicates that the interbank market is prone to volatility during periods of tight liquidity in the market The CBK is mandated by law to apply its monetary policy tools to manage market liquidity conditions and mitigate volatilities;

iv. CBK argues that not all banks participate in the interbank market but only those in need of short-term liquidity and that interbank borrowed funds would not be used for lending purposes. The interbank market is open to all banks to participate and reflect the only market-based wholesale market that banks use for liquidity management It is the shortest end of the yield curve

In conclusion, KBA does not support the CBK proposal contained in the consultative paper. KBA views that:

1. By rejecting the interbank rate as a preferred unified base rate and instead proposing the CBR, the CBK will have the leeway to choose to avoid operationalizing the policy decision after setting the CBR. Setting the CBR without triggering its transmission will lead to a misalignment of market outcomes from the policy intentions;

2. By requiring banks to submit their proposal on premium 'K' for review and noting by CBK before banks roll out their pricing model, CBK aims to control both the base rate and the premium added on the base rate. This is indirectly re-introducing interest rate controls in the economy, against the law that prescribes market-driven interest rates. Introduction of interest rate controls will drive lenders to shun lending to segments of the economy that are perceived to be risky, such as small businesses and low-income individuals, akin to what happened in the interest rate capping period. This will constrain lending to MSMEs and the financing of economic growth and development.

3. The banking industry looks to engage and work with CBK to address the challenges in credit pricing, transparency, and realize affordable credit flow to Kenyans and businesses.

Raimond Molenje, CEO, Kenya Bankers Association, 30th April 2025