Effects of the Central Bank of Kenya’s discount rate on aggregate agricultural lending by financial institutions in Kenya
Date
2022
Authors
Kinuthia, Simon
Journal Title
Journal ISSN
Volume Title
Publisher
Strathmore University
Abstract
Agriculture contributes substantially to the economy of Sub-Saharan African nations. In Kenya, it contributes up to 26% of the annual Gross Domestic Product (GDP) and is a significant employer. Previous research indicates that the sector receives minimal funding from banks, which subsequently limits production. Banks' portfolio lending to agriculture is estimated to be between 3% and 5% of their total lending business with farming considered a high-risk business. Through the monetary policy tools, which include interest on reserve, reserve requirements, discount rate, and open market operations, the Central Bank of Kenya (CBK) plays a very crucial role in regulating the flow of money within the banking system. The CBK can thus increase or limit banks' lending to borrowers. However, there is a lack of knowledge on the extent to which the monetary policy in Kenya influences lending to the agriculture sector. Notably, this study aimed at assessing the effect of the discount rate on aggregate agricultural lending by financial institutions regulated by the CBK. Specifically, the study objectives intended to establish how the discount rate’s expansionary, contractionary, and incentives/ innovations measures affect aggregate lending to agriculture by CBK-regulated financial institutions. The study was anchored on the both the Klein-Monti loan-pricing model and the quantity theory of money as these models exposit the factors that lenders consider while advancing credit to borrowers. The study adopted a correlational research design and relied on a time-series approach involving data drawn from the years 2011 to 2021. The unit of analysis was the CBK with data aggregated from 38 Commercial Banks and 14 Microfinance Banks. The study employed purposive sampling to focus on the CBK-regulated financial institutions. The research involved the collection of quantitative aggregated agricultural lending and discount rate time-series data from published CBK reports and other reliable research sources. Data analysis on the relationships between the independent and dependent variables involved both descriptive and inferential statistics. From the study variables, the correlational analysis results indicated an inverse relationship between the discount rate and aggregate lending to agriculture by the CBK-regulated financial institutions (R= - 0.32). As such, a decrease in the discount rate (expansionary measure) would lead to an increase in aggregate lending to agriculture. The reverse is also true. In addition, from the regression analysis, the study also established that changes in the discount rate had a statistically significant inverse effect on the banks’ monthly aggregate lending to agriculture (β = - 1.68) with a unit change in the discount rate resulting into a 168% inverse change in the monthly aggregate lending to agriculture. In other words, by decreasing the discount rate, the CBK can promote lending to the agriculture sector. Lastly, the CBK can adopt the seasonal discount window credit to allow smaller community banks with agricultural lending products to access the discount window funds thus facilitating increased lending to the agricultural sector.
Description
A Dissertation Submitted in partial fulfillment for the award of the Degree of Master of Management in Agribusiness, Strathmore University