Nature and Dynamics of Adjustment of Commercial Banks' Retail Rates to Monetary Policy Changes in Kenya
Loading...
Date
2014-03-10
Authors
Makambi, Steve Anyona
Journal Title
Journal ISSN
Volume Title
Publisher
Abstract
In Kenya, commercial banks are the most dominant financial intermediaries owning 80 per cent of
financial sector's assets. In this regard, they provide a crucial link in monetary policy transmission.
CentralBank of Kenya reports show that adjustment of commercial banks retail rates to monetary
policy changes isĀ· sluggish thereby posing serious challenges to effective monetary policy
transmission. Recent theories - more so New Keynesian and Post Keynesian theories - postulate
thatcommercial banks' pricing behaviour and financial sector environment have important bearing
on money supply process. Therefore, evaluation of commercial banks pricing and responsiveness
to monetary policy changes is vital in understanding efficacy and conduct of monetary policy. This
study investigated nonlinear adjustment of commercial banks retail rates to monetary policy
changes in an attempt to understand nature and dynamics of monetary policy transmission in
Kenya. The specific objectives are; to measure speed of adjustment of bank retail rates to
monetary policy changes; to examine how speed of adjustment changes in the event monetary
policy switches regime; to investigate how speed of adjustment varies with time; and to evaluate
whether speed of adjustment is simultaneously time varying and asymmetrical in regime
switching. The investigation used Autoregressive distributed lag model formulated from Monti-
Klein profit maximization model. Autoregressive distributed lag model was remodeled into one
linear and three nonlinear error correction models. The study utilized monthly time series data
from June 1993 to February 2012. Data was sourced from CBK. The results revealed that
adjustment towards equilibrium is sluggish and nonlinear. Firstly, speed of adjustment of
commercial bank retail rates to monetary policy changes ranges from 5 per cent per month to 15
per cent per month. Secondly, speed of adjustment is regime switching. For example, lending rates
are rigid downwards as they adjusted faster during expansionary monetary policy regime
compared to contractionary monetary policy regime. In addition, there was evidence that speed of
adjustment is simultaneously time varying and regime switching. However, time varying
adjustment is less pronounced. The study concluded that factors such as inefficiency in financial
market, structural rigidities and nature of competition in the money market have an important
bearing on commercial banks pricing behaviour and in turn explain sluggish and nonlinear
adjustment of commercial banks' retail rates to monetary policy changes in Kenya. The study
recommended that Central Bank should include nonlinear aspects such as sign asymmetry and
magnitude asymmetry in forecasting and prediction of future monetary policy action.
Description
Department of Applied Economics, 2012