The Central Bank of Kenya has moved to cushion small lenders from liquidity challenges that may be associated with interbank lending.

This is after the regulator introduced a new interest rate corridor that stipulates the rate at which the banks should lend to each other.

The Creation of an interest corridor is a strategy where interbank lending rates are restricted to stay within a range.

This approach serves to regulate the interest rates that banks can impose and enhance the effectiveness of translating decisions made by the Monetary Policy Committee.

“The MPC approved measures based on inflation targeting and introduced an interbank interest rate corridor around the Central Bank Rate (CBR) set at CBR plus or minus 2.5 percent," CBK said in a statement.

The move is a welcome relief for small banks that have found themselves in a funding squeeze amid a sharp rise in interest rates, which has impacted the cost of money in the interbank market.

Banks usually access part of their funding by borrowing from each other to plug their deficit.

Banks locked out of the interbank market have in recent weeks turned to the CBK, which is the lender of last resort to smoothen their funding needs.

The increased dependence on CBK by tier two and three banks for financing has seen a drop in the sector’s total deposits held by the regulator.

Kenya Bankers Association (KBA) pointed out that the tighter funding conditions have been more profound on small banks, which mostly struggle to access funding from bigger players on perceived risks.

CBK governor Kamau Thugge said the monetary policy operations will be aimed at ensuring that the interbank rate, as an operating target, closely tracks the CBR.

The framework allows the CBK’s open market operations to be conducted on the basis of a flexible rate fixed quantity as is currently the case.

This implies that the CBK will determine the amount of liquidity to inject or withdraw from the banking system and banks will be free to bid for the amount of liquidity they need or offer at their bid or offer price.

Last week commercial banks’ reserves stood at a shortfall of Sh4.7 billion in relation to the cash reserve requirement ratio (CRR) requirement, marking a third straight week of reduced liquidity in the banking sector and money market.