The Central Bank of Kenya has taken steps to safeguard smaller lenders against potential liquidity issues stemming from interbank lending. This move comes as the regulatory body introduces a novel interest rate corridor that prescribes the lending rate applicable between banks.
The concept of an interest corridor involves defining a range within which interbank lending rates must operate. This strategy serves to control the interest rates that banks can apply, thus enhancing the efficacy of decisions made by the Monetary Policy Committee.
The Central Bank of Kenya elaborated in a statement that the endorsed measures by the Monetary Policy Committee are rooted in inflation targeting. They have implemented an interbank interest rate corridor centered around the Central Bank Rate (CBR), set at CBR plus or minus 2.5 percent.
This development is particularly advantageous for smaller banks that have grappled with a liquidity crunch due to a significant surge in interest rates. The amplified interest rates have affected the cost of capital in the interbank market.
Traditionally, banks secure a portion of their funding by borrowing from one another to fill financial gaps. However, certain banks that have been excluded from this interbank market have recently turned to the Central Bank of Kenya, their lender of last resort, to stabilize their funding requirements.
This mounting reliance on the Central Bank by secondary and tertiary banks for financial support has contributed to a decrease in the overall deposits held by the regulator.
The Kenya Bankers Association highlighted that the more stringent funding conditions have disproportionately impacted smaller banks, which often encounter difficulties in obtaining funding from larger counterparts due to perceived risks.
CBK Governor Kamau Thugge clarified that the primary goal of monetary policy operations is to ensure that the interbank rate closely aligns with the CBR.
This framework enables the Central Bank’s open market operations to be executed based on a flexible rate-fixed quantity approach, much like the current setup. Consequently, the Central Bank will decide the volume of liquidity to infuse or withdraw from the banking system. Banks will have the freedom to bid for the desired liquidity volume or offer liquidity at their proposed prices.
In recent times, commercial banks have experienced a shortage of reserves amounting to Sh4.7 billion relative to the cash reserve requirement ratio (CRR). This has marked the third consecutive week of diminished liquidity in both the banking sector and the money market.