The Central Bank of Kenya (CBK) has retreated from its plans to control lending rates using its benchmark rate, handing a victory to commercial lenders who preferred to use the interest charged on short-term loans between banks to determine borrowing costs.
Official correspondence between the CBK and commercial banks shows that the banking sector regulator has made a U-turn and abandoned its earlier proposal that lenders use the Central Bank Rate (CBR) as the base for pricing loans.
Instead, the market will now use the average interbank rate —fronted by industry lobby Kenya Bankers Association (KBA)-- to determine consumer borrowing costs.
“CBK proposes the use of the interbank rate as the common reference rate for determining lending rates for all customers. The total lending rate will be the interbank rate plus a premium (K),” the CBK said in a document dated July 20, 2025 seen by the Business Daily.
“The use of the interbank rate as the common reference rate is recommended as it is market-based. Further, the interbank rate closely aligns with the policy rate under the current monetary policy implementation framework.”
The bankers and the CBK agreed that the current model, where each bank has its base rate, has failed to take the cue from monetary policy actions like cuts on the benchmark rate or CBR and deliver cheaper credit to Kenyan borrowers fast enough.
The interbank rate currently stands at 9.62 percent while CBR is at 9.75 percent.
The CBK proposal will usher in a framework of a uniform base rate for Kenya’s 38 banks, and eliminate the current model where consumers are unaware of how it is determined.
The interbank market rate refers to the rate at which commercial banks borrow and lend money among themselves on a short-term basis and is widely relied upon as the gauge of how liquid the market is.
The premium K will be a factor of a bank’s operating costs related to its lending business, the expected return to shareholders, and the borrower’s risk premium.
The interbank rate, however, has limits in terms of volatility because it operates within a corridor anchored on the CBK benchmark rate to ensure the benefits of monetary policy is transmitted to the real economy.
The CBK in April reduced the width of the interest rate corridor around the benchmark rate to plus or minus 75 basis points from plus or minus 150 basis points on the central bank benchmark rate.
This means that the interbank rate cannot rise above 0.75 percentage points of the CBR of 9.75 percent or 10.50 percent, and not less than 9.0 percent. While ceding ground to the demand by commercial banks on the use of the interbank market, the CBK differed with the lenders on calculating the base rate.
Commercial banks had proposed the use of a simple average of interbank rates over two months. The banking regulator wants the rates to compound, where they add the interest accrued to the initial principal on each day over the period of concern.
The apex bank argues that the use of compounding in arrears, as opposed to the simple average, will stave off the risk of failed transmission of monetary policy and the inability of borrowers to benefit from cuts in the CBK’s benchmark rate, as was witnessed in 2024, recurring again.
“The simple average rate is based on past market conditions, which may not align with the actual interest period, particularly during periods of volatility or shifting rates,” CBK said of its argument for shooting down the use of the simple average interbank market rate.
“Additionally, it may delay the transmission of monetary policy changes. This approach overlooks daily market fluctuations, which may potentially mask signs of short-term funding stress or ease.”
The regulator backed the use of compound interest.
“Compounding in arrears allows immediate transmission of monetary policy to the real sector through adjustments in bank interest rates and responds in real time to changes in market conditions,” said the CBK.
“It minimises the impact of temporary spikes on interest rates caused by unusual supply and demand factors affecting the benchmark rate on a particular day. It is based on transaction-based overnight rates reflecting the actual cost of funds.”
Banks have since 2019 applied the risk-based credit pricing model to determine lending rates, which allows the pricing of loans according to the perceived risk of individual borrowers.
Despite the CBK approving the risk-based credit pricing models for all banks last year, the regulator noted that some banks failed to adhere to the framework, resulting in good borrowers paying more for credit despite a lower risk profile.
In the first CBK Monetary Policy Committee meeting for the year, held on February 5, the CBK Governor, Kamau Thugge, warned banks of penalties for failing to lower lending rates in line with cuts of the benchmark rate.
Between August 2024 and June 2025, the CBK slashed its benchmark rate by 3.25 percentage points to 9.75 percent, while the average commercial bank lending rate declined by a marginal 1.19 percentage points to 15.7 percent.
Over the same period, the yield on the 91-Day Treasury bill declined by 734.0 basis points to 8.5 percent.
The CBK has in the past dismissed the argument by commercial banks that it is their holding of expensive deposits that stifled their ability to transmit declining interest rates to borrowers.
