Analysis of the interest rate pass through from the central bank rate to mortgage lending rates in Kenya
Monetary policy is deemed to be effective when the transmission process is complete; in this case , if it moves from the Central Bank Rate to the long term mortgage rate. However, the Central Bank of Kenya has often been criticized for its inability to force banks to reduce their lending rates. To test this effectiveness, using monthly time series data from June 2002 to December 2013 , the paper analyzed the speed of adjustment of mortgage rates in Kenya to changes in the Central Bank Rate (CBR) using mortgage rates from the 15 commercial banks that offer mortgage finance. The study focused on a twostep process: transmission from the CBR to the short term rate and from the short term rate to the mortgage lending rate . An Error Correction Model was used to determine the speed of adjustment. The results revealed that the interbank rate adjusted to a change in the CBR at a speed of 39.25 per cent per month, which is slow given that it is below the 50 per cent half mark. Mortgage rates in turn adjusted to a change in the interbank rate at a speed of 13.6 per cent, which is very slow. This shows that the transmission process is sluggish and incomplete, especially as regards adjustment of the mortgage lending rates to changes in the CBR. This could possibly be as a result of collusive behavior among banks, the need to recover sunk costs and the habit of banks following non-profit maximizing behavior. Further research should be done to find out solid reasons why the mortgage rates are sticky so as to enhance the understanding of the dynamics of interest rates in Kenya.