The Central Bank of Kenya (CBK) has withdrawn its proposal to control lending through the Central Bank Rate (CBR), conceding to commercial banks’ preference for using the interbank rate as the basis for determining borrowing costs.
According to a CBK document dated July 20, 2025, the monetary authority proposed using the interbank rate as a common reference rate for determining lending rates and stated that the total lending rate will be the interbank rate plus a premium K.
Commercial Banks Interbank rate
The interbank rate refers to the rate at which commercial banks charge each other when they lend money to one another, usually on a short-term basis, sometimes overnight.
Banks temporarily experience liquidity problems and need money to satisfy regulatory requirements, maintain reserve levels at the CBK, and meet daily payments; hence, they borrow from other banks that have extra cash and pay with interest. The rate is also market-driven – it is influenced by the changes in demand and supply between banks.
“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.
In April, the lender of last resort reduced the range within which the interbank rate is allowed to move around the CBR to plus or minus 75 basis points from plus or minus 150 basis points. Currently, the interbank rate stands at 9.63%.
Premium K
This is an additional amount added on top of a lending rate to calculate the final interest charged to a borrower. It constitutes the bank’s operating costs related to lending, expected return to shareholders, and borrowers’ risk premium. Each bank will tailor its value (Premium K) depending on its costs, profit targets, and borrower risk.
Despite the fact that the apex bank agreed to use the interbank rate as a reference, it disagreed with banks on the formula to be used to determine the interbank-based rate. Commercial banks advocated for a simple average of interbank rates over the 60 days, while the CBK wanted the rates to compound.
The monetary authority argued that the use of compounding in arrears – where interest is calculated based on actual daily interbank rates and applied afterwards- would lead to a more accurate reflection of the prevailing market conditions.
The simple average formula might not reflect the real-time changes. The CBK said that the use of the daily compounding method will make sure that when changes are made to the CBR, banks pass the benefit or cost to borrowers.
“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.
Since June 2024, the CBR has lowered its rate from13% to 9.75% in July 2025.
