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How private sector, banks got wedged in credit tussles
CBK data shows while lending to the private sector has been largely stagnant, investment in government securities by banking institutions has been growing.
Private sector credit has stagnated in recent years owing to a high-interest regime, which has traditionally prompted financial institutions to invest money in government securities that are risk-free.
Kenya’s businesses and enterprises have largely struggled to access new loans from banks in a tough economic setting characterised by high default rates amid a reduction in disposable income for households and deepening cash flow woes for businesses.
During the recent peak in average bank interest rates at 17.22 percent in November 2024, lending to the private sector contracted at an annualised rate of 0.6 percent —the first annualised dip since 2002.
Falling interest rates have seen the flow of credit to the private sector dip at a slower pace.
For instance, during the first quarter of the year, lending to the private sector dropped at a slower rate of 0.52 percent quarter-on-quarter compared with 2.10 percent last year.
How did we get into a high-interest regime?
The Central Bank of Kenya, just like its peers across the world, used its key lending rate as a tool to lower inflation which had remained stubbornly elevated in the wake of global supply chains, amongst other risks, from 2022.
The apex bank raised the central bank rate (CBR) — the lowest rate it can lend money to commercial banks— from 7.0 percent in early May 2022 to 13 percent in June 2024.
The CBK uses the monetary policy tool to signal commercial banks to raise interest rates and control demand-side price pressures.
This is because the higher cost of loans tends to prompt households and businesses to postpone borrowing for expenditures that are not urgent such as replacing cars and furniture, thus lowering demand for such goods and, therefore, slowing down the rate of price increment.
That, coupled with improved production of food crops because of subsidised farm inputs and favourable weather, helped lower the rate of annual growth in average prices of goods and services from a recent peak of 9.59 percent in October 2022 to a 17-year low of 2.72 percent two years later in October 2024.
Elevated interest rates also helped attract return-chasing foreign investors to pump dollars into Kenya’s financial and capital markets, including government securities, partly boosting inflows of dollars and helping ease the pressure on the shilling.
How did elevated interest rates impact lending to the private sector?
Commercial banks’ lending to enterprises and businesses contracted last year when the CBR rates hit levels last seen in October 2012.
CBK data, for example, shows credit to the private sector— the main driver of economic activity including jobs— contracted 1.37 percent to Sh3.86 trillion in 12 months ended December 2024 compared with 13.91 percent growth in the prior year. That was the first annual contraction in the review closing period since 2001.
The contraction came in an environment of high cost of borrowing which locks some businesses and households out of the credit market due to their risk profile. Small and medium-sized enterprises particularly find it difficult to get loans to expand their ventures due to perceived high risk of default.
On the other hand, businesses also cringe at high interest rates by lenders, prompting them to postpone investments.
The contraction in loans to the private sector could also be partly attributed to the revaluation of dollar-denominated loans in sectors such as finance and insurance, manufacturing, building, and construction as well as trade after the shilling gained about 17.6 percent against the US dollar.
That meant the value of dollar-denominated assets, including loans, was reduced by similar margins when converted to shillings.
How did banks shift lending to the government from enterprises and households?
CBK data shows while lending to the private sector has been largely stagnant, investment in government securities by banking institutions has been growing.
For instance, flow of credit to the private sector fell a marginal 0.52 percent to Sh3.84 trillion in March from Sh3.86 trillion last December. Investments by banking institutions in government securities, on the other hand, rose 4.97 percent to Sh2.78 trillion in the review period, based on domestic debt data.
How has the CBK cut the CBR rate after inflation rate slowed?
Inflation stood at 4.11 percent which is within the CBK’s target band of between 2.5 and 7.5 percent — it has been below 5.0 percent since July 2024. The CBK’s monetary policy committee (MPC) has cut the CBR from 13 percent in early August last year to the current levels of 9.75 percent, the lowest since June 2023.
Have banks lowered interest rates as a result of reduction in CBR?
Weighted average lending rates have fallen from a recent peak of 17.22 percent last November to 15.65 percent in April. The CBK governor Kamau Thugge has not been satisfied with the pace at which commercial lenders are cutting the cost of loans.
The CBK has, as a result, started physical inspections of banks in February to ascertain whether lenders have complied with a directive to reduce lending charges on loans in line with their risk-based credit pricing models.
The inspections are expected to be completed this month, after which the regulator has threatened to start imposing fines on non-compliant commercial banks.
What reasons do banks give for not cutting rates immediately the CBR is lowered?
The lenders argue that when the CBR goes up, term depositors demand higher interest rates, but do not transfer the entire cost to borrowers at once. When the CBR goes down, they act in line with movements in returns that depositors are demanding.
