On 8th July 2014, the Central Bank of Kenya set the first KBRR at 9.13% and it became effective from that very same day. As a move to foster transparency in Kenyan financial sector, the reference rate is both timely and effective.
KBRR comes in to replace the Base Lending Rate (BLR) that banks used to price their loans previously. The BLR used to vary from one bank to the other and there was a transparency gap such that clients could not tell which bank is offering better rates than the other. To remedy this issue, the Central Bank of Kenya set up a new common reference rate for all banks which is the Kenya Banks’ Reference Rate (KBRR).
Under the new policy, all banks shall be using the KBRR as their basic reference rate and add a premium to it to cover their cost of capital, margins and risks. To arrive at the KBRR, the Central Bank of Kenya shall factor in the CBK’s monetary policy direction (read ->Central Bank Rate – CBR) and the risk free rate prevailing in the market (read ->91-day Treasury Bill interest rate).
The Total Cost of Credit (TCC) to the client shall therefore be comprising of the KBRR plus the premium added by each bank. As stipulated above, the premium shall be made up of the bank’s cost of funds, margin and risk. Also included in the TCC are the third party costs which include: insurance, valuation, legal fees and government levies.
In 2012, the Kenya Bankers Association voluntarily adopted the Annual Percentage Rate (APR) pricing model. APR is the numerical representation of the Total Cost of Credit discussed above. It’s implementation was undertaken in 2013 with the effective date being 1st July 2014.
APR and the TCC should be provided to all loan applicants before signing any loan contract. This will enable clients to compare the cost of borrowing from different lenders and shop around for the most favorable rates. In addition, this will lead to competitive pricing of loans by the commercial banks and thus result to lower borrowing rates for clients.
The transparency brought about by the KBRR and the APR are timely and will go a long way to changing the interest rates dynamics in our Kenyan financial sector into the future.
All we can hope for is that the common reference rate (KBRR) and the disclosure of the total cost of credit though the APR will translate to lower borrowing rates in the market. If this hypothesis turns out to be positive, then we expect borrowing for business expansion, increased production, increased consumption and ultimately a hike in our GDP.