The determinants of volatility of the lending interest rate in Kenya
Date
2014
Authors
Githiaka, Teresa Nyokabi
Journal Title
Journal ISSN
Volume Title
Publisher
Strathmore University
Abstract
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?
Description
A Thesis submitted in partial Fulfillment of the requirements for the Degree of Master in Commerce
Keywords
Lending interest rate, Business, Banking, Kenya