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The bank raised its discount window rate to 8.00 percent on June 29 from 6.25 percent, in a surprise move described by analysts as a step in the right direction towards curbing inflation in east Africa's biggest economy. 

At the time of the increase, the bank said one reason for the rise was to stop banks using the overnight window to fund foreign exchange positions. The overnight rate is now back in line with the bank's benchmark Central Bank Rate (CBR).

"I will not call it a reduction, but an abandonment of the window rate for the CBR," said Philip Wambua, head of foreign exchange and treasury at Bank of Africa.

The shilling fell against the dollar after Tuesday's announcement to its weakest level since June 27.

"Central banks always run discount windows as facilities of last resort as a means of providing temporary liquidity to banks in extreme cases," the Central Bank of Kenya said in a circular to commercial bank chief executives.

"The CBK is concerned that recently, commercial banks have not been using the discount window as a last resort, but as a permanent supply of liquidity," it said

The central bank said any bank lending to others on the interbank market would henceforth be denied access to funds from the discount window on the same day.

It said commercial banks would be limited to borrowing a maximum of their statutory cash reserve from the window between Monday and Friday on any given week.

The regulator added that due to the restrictions on borrowing through the window, banks should seek other means of meeting their liquidity needs.

"In this regard, they should consider liquidating their portfolios of Treasury bills, Treasury bonds or foreign currency positions, among others, prior to resorting to the discount window," the bank said.