Kenya’s banking sector is undergoing a gradual shift in how lending rates are determined, reflecting broader reforms in credit pricing following the repeal of interest rate caps in 2019. The Risk-Based Credit Pricing Model (RBCPM) introduced by the Central Bank of Kenya was designed to improve transparency in loan pricing by linking lending rates to measurable cost components while allowing banks to price credit according to borrower risk. Traditionally, the framework was anchored on the Central Bank Rate, meaning lending rates were typically expressed as CBR plus a bank-specific premium (K). This premium incorporates the lender’s cost of funds, operational expenses, credit risk assessment and profit margin. In principle, this structure maintained the policy rate as the central reference point while allowing flexibility in credit pricing.
Recent reforms, however, suggest a gradual shift toward a more market-based benchmark. Banks are increasingly encouraged to reference the Kenya Shilling Overnight Interbank Average Rate under the revised RBCPM framework. KESONIA reflects the average overnight rate at which banks lend to one another in the interbank market and therefore captures prevailing liquidity conditions within the financial system. Unlike the policy rate, which is adjusted periodically by the Monetary Policy Committee, KESONIA fluctuates daily based on demand and supply for short-term funds among banks. Anchoring lending rates to this benchmark effectively changes the pricing structure from CBR + K to KESONIA + K, allowing loan pricing to track market funding costs more closely.
The rationale behind the shift is largely centered on improving the efficiency of monetary policy transmission. Because KESONIA responds immediately to liquidity conditions, movements in the interbank market may feed more quickly into lending rates compared with a system anchored solely on the policy rate. If market liquidity tightens, the benchmark rises and borrowing costs adjust accordingly; when liquidity improves, the benchmark declines. In theory, this allows the pricing of credit to better reflect real funding conditions within the banking system rather than relying exclusively on policy rate signals from the Central Bank of Kenya.
Nevertheless, the risk-based framework still leaves significant discretion to banks through the K component, which represents the risk premium charged to borrowers. Because this premium is determined internally based on each bank’s credit assessment models, lending rates may continue to vary considerably across institutions even when a common benchmark is used. As a result, while the shift toward KESONIA may make loan pricing more market-responsive, the extent to which borrowers experience lower or higher lending rates will ultimately depend on how banks evaluate credit risk within their portfolios.(Start your investment journey today with the cytonn MMF, call+2540709101200 or email sales@cytonn.com)
