IMF wants interbank interest rate controlled

The IMF has faulted Kenya’s interest rate management, saying the continued lack of control over the rate at which banks lend to each other has reduced the effectiveness of the Central Bank Rate (CBR) in loans pricing.

An IMF working paper on monetary policy implementation and volatility in yields in Kenya says the highly volatile interbank rate is leading to instability in the Treasury Bill rate, a key component in cost of loans in the country.

Banks have often cited the high interbank rates when resisting efforts to bring down borrowing rates. The average lending rate charged by banks stands at about 18 per cent.

“Changes in policy rate may not have the intended effect on funding costs for longer-term maturities, if accompanied by increased volatility of the overnight market interest rate, all else equal,” said IMF in the paper.

“We find significant spill overs of volatility from the overnight interbank rates onto longer-maturity T-Bill auction yields in Kenya.”

Larger, dominant banks, which enjoy high liquidity especially lend to rivals on their own terms. This makes it harder for banks to price loans effectively since they have to factor in the cost of trading with each other as interest expense.

Lenders are currently advancing to one another at 3.5 per cent. 

Deviate from the policy rate

In the meantime, the CBR was mid last year raised for only the first time in two years by 300 basis points to 11.5 per cent. In the most recent MPC meeting last month, CBK returned to a loosening stance by effecting a cut of 100 basis points to 10.5 per cent.

READ: Lower rates expected as MPC meets

In a comparative analysis with other countries, which are pursuing a similar monetary policy framework, IMF said that Kenya’s overnight rates seem to deviate from the policy rate more persistently compared to Uganda and South Africa.

The IMF had earlier this year disclosed that CBK was planning to implement an interest corridor — setting the upper and lower limits — on interbank rates to align it with the Central Bank Rate (CBR), although the regulator has not indicated when it intends to do this.

“Creating a narrower corridor would force a faster rate of convergence in overnight rates, reduce persistence in volatility, and mitigate absolute volatility along the yield curve ... this effort should be supported by other policies such as enhancing coordination between fiscal and monetary operations and improving the market infrastructure,” says the IMF in the paper.