Why commercial banks could be forced to lower interest rates

National Treasury Cabinet Secretary Henry Rotich.

Kenya: Commercial banks could be forced to lower interest rates further to shed off excess cash, which in most cases, finds its way into government securities. The expected development follows the scaling down of Government borrowing requirements from the domestic market.

National Treasury Cabinet Secretary Henry Rotich says Government policy of controlling interest rates through action in the money markets, has begun bearing fruits. He said state policy is to have a regime of low interest rates that would drive private investment, spur economic growth and generate more employment.

Budgetary needs

He, however, clarified that the Government cannot completely keep off the domestic market due to pressing budgetary needs. “We didn’t say we are going to stop borrowing from the domestic market completely. We are still borrowing but at a reduced amount. We have to borrow at least every week,” Rotich told The Standard adding, “If you look at the rates in the market, they have now come down by about 300 basis points since June 2014.”

According to Central Bank of Kenya (CBK), the money market remained tight during the week ending last month, on account of limited flows of government payments. But returns on the 91-Day Treasury bills dropped to 8.475 per cent in July 31, from 11.438 per cent in June 26. The 182-day Treasury bill rates fell to 9.296 per cent in July 30 from 11.585 per cent in June 25, while the rates on the 364-Day Treasury bills plunged to 10.33 per cent from 11.186 per cent in similar period.

Lower rates

National Treasury is grappling to plug part of its budgetary deficit in the 2014/2015 budget estimated at Sh342.6 billion. But in an attempt to control the high interest rates in the country, Rotich said the State will reduce part of the Sh190.8 billion earmarked for borrowing from the domestic market in the current (2014/2015) fiscal year. “We should be able to see interest rates coming down. The rates on the 91- Day Treasury bills have already started going down because we are not in the market now,” he said.

Last month, the Central Bank’s Monetary Policy Committee retained the Central Bank Rate (CBR) at 8.5 per cent, signaling a downward trend in interest rates.

While the intention has been to prompt commercial banks to avail cheaper credit to borrowers, the monetary policy instrument has largely not achieved its objectives. This is because the signals have only impacted on the short-term rates which have continued to decline consistently with a reduction in the CBR.

The onward transmission of the signals to longer-term rates (lending rates) has remained slow, mainly because it works through the commercial banks’ portfolio. Although the CBK and Treasury have constantly piled pressure on banks to lower lending rates, the response has been slow or subdued.

The mismatch between deposit and loan tenures, high cost of operation and the borrowers’ risk profile stands amongst the major causes of high lending rates and the banks’ reluctance to lower lending rates.

Even though central bank has frequently cut the bank’s prime lending rate (CBR rate) to spur household and business spending, majority of banks tend to ignore the signals, citing high cost of funds and the overall cost of doing business in the country.