Interest on Bank Loans to Hit 28% as CBK Raises Base Rate

Borrowers of bank loans are bracing for a hike in interest rates after the Central Bank of Kenya (CBK) raised the benchmark lending rate to an 11-year high.

The CBK’s Monetary Policy Committee (MPC) met on Tuesday, December 5, where it raised the Central Bank Rate (CBR) - the rate at which it lends to commercial banks - to 12.5% from 10.55% previously.

This increase of two percentage points is the highest increase in five years, as the Kenya Kwanza administration works towards bringing down inflation that in November stood at 6.8%.  

• The 12.5% rate is at its highest point since September 2012 when it stood at 13%
• It’s the highest hike since the November 2011 when it was raised by 5.5 percentage points to 16.5%

The hike was mainly predicated on the US$/Kes exchange rate where the Shilling has been on a free fall. This is as noted by a statement from the MPC;

• Exchange rate depreciation continues to exert upward pressure on domestic prices, thereby increasing the cost of living and reducing purchasing power. 
• Of the overall inflation of 6.8% in November 2023, the exchange rate depreciation contributed about 3.0 percentage points. 
• The Committee noted that public sector external debt service has risen, thereby offsetting some of the gains made towards the Government’s strong fiscal consolidation. 
• The continued weakening of the exchange rate is contributing to a significant increase in the Kenya shilling value of foreign currency denominated debt. 

“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,”  the statement reads in part.

Expensive bank loans

With this increase in the base lending rate, a corresponding increase in bank interest rates is expected as commercial banks reprice their current and new loans in line with the CBR.

Currently, the average rate of interest charged on a bank loan is 19.1% with some banks charging customers they deem high risk as high as 26.5% per annum on a reducing balance basis.

If the banks pass the additional 2% to consumers, the average interest rate on a bank loan will rise to 21.1% with some customers facing rates as high as 28%. This is in line with risk-based loan pricing policies adopted by top commercial banks in Kenya that have already been approved by the CBK. 

At 28% per annum, bank loans are now edging closer to mirroring rates charged by microfinance institutions - that have less stringent loan eligibility requirements. 

Higher cost of loans may further shrink access to credit for businesses limiting job creation potential. There are also fears that defaults rates may rise as borrowers already burdened by the rising cost of living and higher taxes could struggle to meet their credit obligations.

The MPC commits to closely monitor the impact of its policy measures on the economy, saying the CBK is ready to further tighten monetary policy if it is deemed necessary to achieve price and exchange rate stability.

The Next MPC meeting is scheduled for February 2024.