Monetary Policy and Private Sector Credit in Kenya
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Date
2024-06
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Kenyatta University
Abstract
The Kenyan banking sector has made significant strides in boosting lending to the private sector,
which contributed around 31 percent of Gross Domestic Product as of 2021, up from 19 percent
in the 1990s. In the past decade, Kenya has enacted several monetary driven policy tools to lower
the cost of private sector advances, including the interest rate ceilings that were implemented in
September 2016. The relatively high cost of lending by financial corporations to individuals and
businesses has been identified as one of the main obstacles to credit expansion in Kenya. To
understand how private sector credit responds to monetary policy changes, this study's main goal
was to research the influence of policy strategy on private sector lending. Specifically, the study
purposed to explore the consequence of changes in the money supply and lending rates on private
sector advances. The study is of significance as it examined the connection between Kenya's
monetary policy and private sector lending with a view to understand how private enterprise
lending responded to changes in money supply and interest rates. The analysis used secondary
data, quarterly macroeconomic statistics 2010-2021 from the Central Bank of Kenya and Kenya
National Bureau of Statistics and applied a vector error correction model, a unit root test was
performed to check for stability, and a Johansen cointegration assessment was performed. This
methodological detail was of importance to establish and analyze the presence of short- or long run relationship among the variables that are cointegrated and affecting private sector lending. The
findings of this study ascertained that there exists a long-term relationship between monetary
policy and private sector credit in Kenya. To determine how changes in interest rates affect growth
of private sector, the research findings show that interest rates and private sector credit are
inversely related in the long-term. This shows that an increase in interest rates by the Central Bank
will result into lower advances of private sector credit as it would become more expensive and
vice-versa. In addition, the results show that the growth of money supply affects growth of private
sector credit that the growth of money supply has a positive impact on the growth of credit to the
private sector as per the long-run estimation. This outcome, therefore, shows that, a reduction in
the money supply causes a decrease in private sector credit, and vice versa. The study has
demonstrated that monetary policy and the expansion of private sector loans are closely related
over time. It is, therefore, unfeasible to underestimate the central bank's influence over the
economy's long run liquidity management through interest rates and money supply by extension,
which impacts several macroeconomic indicators. By implementing accommodative monetary
policies that directly affect cost of credit to individuals and firms and, additionally, encourage
investment through borrowing by fostering confidence in the nation's financial sector of the
economy, the Central Bank of Kenya plays a crucial role in creating the most favorable conditions
to foster credit advances to the private sector which has a direct effect in supporting economic
growth across key sectors and indirectly offering more employment opportunities as the sectors
continue to expand. Further studies to get more insights on how private sector credit responds to
monetary policy changes can investigate the channels through which changes in monetary policy
affect credit availability to the private sector, in addition, the impact of digital banking on the
private sector lending can be explored.
Description
A Research Project Submitted to the School of Business, Economics and Tourism in Partial in Fulfillment of the Requirements for the Award of the Degree of Master’s in Economics of Kenyatta University, June 2024
Supervisors:
Martin Etyang