Im­pli­ca­tions of chang­ing the base rate

The Star (Kenya) - - News - KAREN KANDIE The writer is a fi­nan­cial & risk con­sul­tant with First Tri­dent Cap­i­tal

The Cen­tral Bank Rate is the of­fi­cial base rate for pur­poses of im­ple­men­ta­tion of the Bank­ing Amend­ment Act 2015 as an­nounced in a CBK cir­cu­lar on Tues­day this week. This puts to rest the ques­tion as to whether the ap­pli­ca­ble rate is the Kenya Banks’ Ref­er­ence Rate (cur­rently 8.9 per cent) or the CBR (cur­rently 10.5 per cent). It also ef­fec­tively makes the KBRR, pre­vi­ously the base lend­ing rate, ir­rel­e­vant to the in­dus­try. This has sev­eral im­pli­ca­tions; but first, what ex­actly are these rates? The CBR is the low­est rate of in­ter­est that the CBK charges on funds it loans to banks as a “lender of last re­sort”. Banks are ex­pected to bor­row from each other in the in­ter-bank mar­ket mainly to main­tain the re­quired ra­tios such as liq­uid­ity. In the rare oc­ca­sion that a bank is un­able to ac­cess credit from other banks, the CBK acts as the lender of last re­sort. The CBR is one of the tools of mone­tary pol­icy. Oth­ers are the open mar­ket op­er­a­tions (buy­ing and selling of gov­ern­ment se­cu­ri­ties), and the re­serve re­quire­ments (the amount of money banks are re­quired to de­posit with the CBK). A lower CBR is re­garded as ex­pan­sion­ary – it en­cour­ages lend­ing and spend­ing by con­sumers and busi­nesses thus in­creas­ing the money in cir­cu­la­tion. A higher rate is con­trac­tionary and does the op­po­site, dis­cour­ag­ing lend­ing and spend­ing, and there­fore re­duc­ing the money in cir­cu­la­tion. Through the low­er­ing and rais­ing the CBR, money in cir­cu­la­tion is reg­u­lated and in­fla­tion is kept within tar­get. The Mone­tary Pol­icy Com­mit­tee pre­vi­ously met ev­ery two months to re­view the CBR. How­ever, the cir­cu­lar is­sued by the CBK pro­vides that this rate will be re­viewed an­nu­ally. While this will pro­mote sta­bil­ity in in­ter­est rates, it comes at the ex­pense of in­fla­tion tar­get­ing be­cause monthly changes in in­fla­tion will not be re­flected on time. The pre­vi­ous base rate, the KBRR, was an av­er­age of the CBR and the weighted two-month mov­ing av­er­age of the 91-day Trea­sury-bill rate. Con­se­quently, by virtue of its com­po­si­tion, it di­rectly linked the base lend­ing rate to the rate the gov­ern­ment bor­rows from the pub­lic through is­su­ing Trea­sury bills. With the shift­ing of the base rate from KBRR to CBR, this di­rect link to gov­ern­ment bor­row­ing is lost. The im­pli­ca­tion of this is that gov­ern­ment bor­row­ing will not be di­rectly re­flected in lend­ing rates, but will in­stead take a de­layed trans­mis­sion through other mar­ket dy­nam­ics. Whether this is good or bad for the mar­ket will per­haps de­pend on the amount the gov­ern­ment de­cides to bor­row. Nev­er­the­less, it does mean that lim­it­ing do­mes­tic bor­row­ing in or­der to avoid crowd­ing out the pri­vate sec­tor, and con­se­quently rais­ing lend­ing rates, may no longer be a ma­jor con­straint in the gov­ern­ment bor­row­ing pro­gramme.

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