The impact of financial liberalization on savings in Kenya

Abstract

Since the onset of the financial liberalization hypothesis, Kenya has implemented far reaching reforms. However, the experience of Kenya with financial liberalization has been predominantly traumatic, and whether financial liberalization impacts positively on savings, remains purely an empirical issue. This paper presents an analysis of effects of financial liberalization on savings in Kenya during the period 1971 to 2004. To see this effect, this study specified and estimated a long-run real savings model with measures of financial intermediation as its variates. The overall assessment of the financial liberalization is positive. The economic results reveal that there is a long-run relationship between real savings and measures of financial intermediation, proxied by domestic credit to GDP ratio and financial deepening measured by (M2/GDP). Real deposits rate has positive impact on private saving rates. After analyzing the various channels through which such an impact can take place, we conclude that the overall net effect is ambiguous. On one hand the result suggests a positive and significant association between private saving and financial intermediation. The estimated coefficient is significant, suggesting that higher credit availability does not reduce private saving. On the other hand the results suggest a negative association between private savings and financial deepening. The estimated coefficient is significance and negative, indicating disavings by private sector as financial assets mcreases. In general the result illustrates that financial liberalization, combined with adequate prudential regulation and strong supervision of banking can breed a sound and deep financial. system able to boost savings over an extended period. It also suggests that larger benefits can be reaped when financial reform does not come as an isolated policy action, but is part of a consistent and comprehensive strategy of stabilization and structural reform in the financial sector. The ambiguity in these results perhaps suggest that liberalization process was introduced in a hurry when the financial sector was in crisis and without proper macroeconomic stability. The study recommends that maintenance of a stable financial system is important for the achievement of positive results from the liberalization process. Policy approaches should be geared towards strengthening the legal infrastructure, in order to lower costs and risks associated with non-performing loans, addressing the high intermediation margins. This will make banks attractive to savers hence increasing financial savings.