The determinants of volatility of the lending interest rate in Kenya
This study sought to measure the volatility and identify the determinants of volatility of the lending interest rate in Kenya. Both secondary and primary data was used. Primary data was obtained from a sample of 44 financial institutions in Kenya. Secondary data was obtained from the Central bank and Kenya National Bureau of Statistics for the periods 1991 to 2012. This study was guided by the Loanable funds theory. In data analysis, the regression, descriptive statistics, F-test and GARCH models were used. The key findings from the study were: (1) The Garch reaction parameter (a) was 0.61426092 while the Garch persistence parameter β was 0.87405664. A high a that is associated with a low β produces a very high Garch volatility. This means that the lending interest rate was characterized by high volatility. Following the introduction of the CBR in 2005, volatility reduced from 84% to 22% (2) the main determinants of volatility the lending interest rate are the expected changes in inflation rate, central bank rate, growth domestic policy, treasury bills and exchange rate. The p values were less than 5% and hence significant; (3) the factors that management of financial institutions take into consideration when they are fixing the lending interest rate include, Central Bank rate of Kenya, expected changes in inflation rate, Credit worthiness of the borrower, expected changes in a country's exchange rate, economic growth measured by the GDP ,the deposit rate, amount of loan, characteristics of the credit market, nature of the collateral, liquidity and solvency of the bank, level of competition, purchase of government bonds by the banks, bank's expected profits, term of the loan, demand for capital, interbank rate and current year country's budget deficit. The research study confirmed the monetary policy, loanable funds and Fisher's theory of interest rate determination. Inflation, CBR and money supply were found to be major determinants of the lending interest rate. Further research was suggested on; why the lending rate has been on an increasing trend yet volatility has reduced since the CBR introduction? How can the bank's balance sheet and regulatory requirements be made optimal so that they don't have to affect the fluctuations of the lending interest rate with great magnitude?