The Effect of exchange rate volatility on lending rates for commercial banks in Kenya

Abstract

This research examined how fluctuations in the exchange rate influenced interest rates charged by Kenyan commercial banks. Given the substantial influence of fluctuating exchange rates on economic activity and financial conditions, this study aimed to understand the relationship between currency changes and borrowing costs in Kenya. While earlier studies have investigated the wider impacts of exchange rate fluctuations on the profitability of banks, the specific impact on lending rates remains understudied. To accurately measure exchange rate volatility and comprehensively analyze its connection to lending rates, the study utilized the ARCH/GARCH models and subsequently a Stepwise Regression of the variables. The study found that while all three currencies showed volatility, only the Euro's exchange rate fluctuations had a positive and statistically significant effect on lending rates. Changes in the Euro influenced lending rate variations, whereas the USD and Ugandan Shilling's volatility did not.