The Central Bank of Kenya (CBK), through its Monetary Policy Committee (MPC), reduced the Central Bank Rate (CBR) from 12.75% in August to a record low of 12.00% on 8th October 2024.
This downward adjustment is expected to reduce the cost of borrowing from financial institutions, such as banks regulated by the CBK.
What Is the CBR?
- The Central Bank Rate (CBR) is the rate at which the CBK lends to commercial banks.
- The CBR rate is usually adjusted by the CBK every two months
- It serves as the benchmark interest rate for the country’s monetary policy.
Source: Central Bank of Kenya where current CBR is 12.0 %
HOW THE CBR INFLUENCES YOUR BANK’S LENDING RATES.
When the CBK changes the CBR, it influences how banks set their lending rates to businesses and consumers.
This is because the cost of commercial banks borrowing from the Central Bank Of Kenya will reduce, which in turn cause a trickle down effect to the borrower.
Ideally, a lower CBR means banks will offer loans at more affordable rates, making it easier for individuals and businesses to access credit.
Commercial Bank Rate = CBR+ Bank Margin
CBR (Central Bank Rate): This is the rate set by the Central Bank of Kenya (CBK), currently 12.00% as of October 2024.
Bank Margin: This represents the additional percentage that commercial banks add to the CBR to cover their operational costs, risks, and profits. The margin can vary between banks based on their risk assessments and cost structures.
How Do Banks Determine the Margin?
In Kenya, banks typically add a margin to the CBR based on several factors:
- Cost of Funds: Banks need to consider their own borrowing costs, such as the interest they pay to depositors or other sources of capital.
- Credit Risk: The higher the perceived risk of the borrower, the higher the margin. Banks assess factors like the borrower’s credit history, income, and ability to repay.
- Operational Costs: This includes the cost of running the bank, from branch operations to staff salaries and technology infrastructure.
- Profit Margin: Banks aim to make a profit from lending, and the margin they add to the CBR allows them to generate returns.
Impact of a Lower CBR on Lending
With the recent reduction of the CBR from 12.75% to 12.00%, commercial banks are likely to adjust their lending rates downward. Here’s how the lower CBR affects lending:
Lower Cost of Borrowing for Consumers and Businesses
Since the CBR is part of the formula that determines the interest rate, a lower CBR means banks can reduce their lending rates.
Previous Lending Rate=12.75%(CBR)+5%(Bank Margin)=17.75%
With the new CBR of 12.00%, the lending rate could drop to:
New Lending Rate=12.00%(CBR)+5%(Bank Margin)=17.00%
IMPACT OF A LOWER CBR ON SAVERS AND INVESTORS
While a lower Central Bank Rate (CBR) is generally good news for borrowers, it can have a mixed impact on savers and investors
1. Lower Returns on Savings Accounts and Fixed Deposits
Commercial banks typically adjust their interest rates on savings accounts and fixed deposits based on the CBR. As the CBR decreases, banks may offer lower interest rates on savings products. This means savers could see:
- Reduced returns on money kept in savings accounts.
- Lower interest earnings from fixed deposits or other similar products tied to the CBR.
For example, if a bank offered a savings rate of 6% when the CBR was 12.75%, a reduction in the CBR might lead the bank to reduce the savings rate to something like 5.5% or lower, depending on the bank’s margin.
2. Shift in Investment Preferences
As interest rates on traditional savings products decline, investors may seek higher returns by moving their money into alternative investment vehicles. These could include:
Real estate: With lower borrowing costs, more people may be inclined to invest in real estate. Investors could shift capital into property investments, taking advantage of lower mortgage rates.
Bonds: While government bonds and fixed-income products may also offer lower yields during periods of declining interest rates, long-term bonds issued before the rate reduction may become more valuable.
Companies may expand: More businesses may borrow to finance growth, leading to increased stock market activity and new opportunities for equity investors.
Existing bonds with higher rates: Investors holding older bonds with higher fixed interest rates could see capital appreciation as these bonds become more attractive in a low-rate environment.
New bond investments: New bonds will likely offer lower yields, which could make them less attractive compared to equities or other growth-focused investments.