A landmark overhaul of how bank loans are priced is set to take effect from 1 September 2025, with the Central Bank of Kenya (CBK) replacing the well-known Central Bank Rate (CBR) with a new market-based benchmark. This change, detailed in a revised Risk-Based Credit Pricing Model (RBCPM), will fundamentally alter the landscape for banks and borrowers alike, introducing a more dynamic but potentially volatile interest rate environment.

The core of the reform is the adoption of the Kenya Shilling Overnight Interbank Average Rate (KESONIA) as the reference point for pricing all variable-rate loans denominated in Kenya Shillings. KESONIA is the formal renaming of the existing overnight interbank rate, which reflects the average interest rate at which banks lend to each other overnight.

This marks a significant departure from the initial proposal of using the CBR. The total lending rate will now be calculated as KESONIA + Premium ("K"). “Premium” will include costs related to lending, return to shareholders and the risk profile of the borrower.  The total cost of credit to the consumer will be this rate plus any additional fees and charges.

CBK’s rationale for this shift is to align Kenya with international best practices, including benchmarks like the UK Sterling Overnight Index Average (SONIA) and the US Secured Overnight Financing Rate (SOFR) which are derived from real-time market transactions. This move is intended to strengthen the transmission of monetary policy and foster a more transparent, market-responsive pricing model. Whilst the CBR will no longer be the primary benchmark, it will serve as a fallback where the KESONIA is impractical. However, this contingency should be provided for in the loan agreements.

This transition shall necessitate a significant overhaul for commercial banks. Banks have three months to develop their own internal risk-based pricing models, secure board approval, and submit them to the CBK. Followed by a three-month period to transition their systems and products ending 28 February 2026. For existing variable rate loans, the revised model will take effect from this date. This requires substantial investment in reconfiguring IT systems to handle the new calculation methodology, updating internal documentation, system references, pricing models, reviewing legal agreements and retraining staff.

A key pillar of the new framework is transparency. All Banks will be required to publish their weighted average lending rates, the weighted average premium ("K"), and all other fees for loan products on the Total Cost of Credit (TCC) website. This public disclosure will allow customers to easily compare costs across institutions, likely intensifying competition and requiring banks to manage their operating costs, which is a key component of the 'K' premium.

The model requires that risk premiums be customer-specific and determined by a detailed credit-scoring model. This reinforces the need for robust credit assessment capabilities to accurately price risk and remain competitive.

For borrowers, the new model brings both opportunities and challenges As it is based on daily market activity, interest rates on variable-rate loans will fluctuate more frequently, introducing a new level of uncertainty for financial planning. On the other hand,  the mandatory disclosures on the TCC website are a win for consumers as they will have a clearer picture of the total cost of a loan, enabling them to make more informed decisions. Borrowers with strong credit profiles will benefit from lower risk premiums.

Although the CBK will publish a daily KESONIA Compounded Index to aid verification, the interest calculation method is complex and borrowers may find it difficult to independently calculate or forecast their interest payments, which are finalized at the end of an interest period.

Foreign currency denominated loans and fixed-rate loans are excluded from the new system as the primary drivers for costing of foreign currency denominated loans are external factors, not local market conditions. The pricing must account for currency risk such as the potential for fluctuations in the exchange rates. Applying the KESONIA to a foreign currency loan would not reflect the bank's actual cost of funding or the associated risks.

Despite the clear objectives, the rollout of the new framework is not without potential challenges. The six-month window for developing and implementing the new models is aggressive. Banks had initially lobbied for a six-month transition period for implementation alone. A rushed implementation could lead to system errors and operational disruptions.

The transition to KESONIA promises a more transparent, competitive, and globally aligned banking approach. However, the complexity of the compounded rate presents significant challenges. To address customer concerns and disputes over interest charges, consumer education shall be paramount. The success of the transparency initiative hinges on the successful and timely revamp of the TCC website into a truly customer-friendly tool. Stakeholders had requested that digital loans, trade finance, and SME loans, be excluded from the model due to their unique structures however the framework applies to all variable-rate loans.

The coming months will be a critical test of the banking sector's agility and its commitment to customer education. The ultimate success of this landmark reform will be measured not just in the efficiency of monetary policy, but in how well ordinary Kenyans are guided across this new financial frontier.

This article was published in the Business Daily on 2 September 2025 and can be accessed here.