The Impact of the Central Bank of Kenya Rate [CBR] on Commercial Banks’ Benchmark Lending interest rates

Abstract

This research project uses a geometric lag regression approach to identify the effects of the Central Bank Rate (CBR) on the Kenyan financial system. This forms the first stage of the interest rate channel of the monetary transmission mechanism, with the second stage explaining the propagation of monetary policy from the financial markets to the real economy. The results indicate that a change in the monetary policy has a significant effect on the money market rate. The change is then propagated through the money market to the commercial banks’ loan rate market. Chapter one gives a historical background of the monetary transmission mechanism, the process by which monetary policy actions influence the economy. A contribution to the literature is provided in terms of a balance between theory and the more technical aspects to the implementation and the transmission mechanism of monetary policy. Contributions to the literature are provided by the findings presented within chapters two, three, and four.The responsiveness of the commercial banks’ lending rates is assessed by regressing the lending rate (L) against a 3-month lagged CBR and a 3-month Lagged Money Supply growth rate (M2), with the commercial lending rate as the dependent variable. In addition to the 3-month lag period the same model was applied to test for CBR responsiveness assuming a 6-month period so that if the responsiveness was not captured with a 3-month lag it would be visible in the 6-month lag failure to which the monetary policy tool could be deemed ineffective within a reasonable time frame.