Relationship between exchange rate fluctuations and the demand for credit among Commercial Banks in Kenya

Abstract

Events in the economy are capable of having many effects in the foreign exchange market. A foreign exchange rate affects several variables which form great basis for demand of credit in an economy. Given the openness of most contemporary economies, money demand functions should include the effect of external monetary and financial factors approximated by movements in foreign rate and exchange rate. The demand for money is one of the key functions in formulating effective and appropriate monetary policy. An understanding of the determinants of the demand for money is important because it bears on monetary theory and policy, and sheds light on how changes in money supply and related variables such as interest rates are transmitted to the economy and on how they affect the level of economic activity. The objective of this study was to establish the relationship between exchange rate fluctuations and the demand for credit among commercial banks in Kenya The research utilized descriptive research and the population consisted of all the commercial banks in Kenya, licensed by Central Bank of Kenya hence a census. The sampling frame was based on time series annual data of the independent and dependent variables for a period of 13 years between 2000 and 2012. Secondary data from the Central Bank of Kenya was used in the analysis. In order to establish the relationship, a regression analysis was carried out. The study findings established that that there was a strong negative relationship between exchange rate fluctuations and the demand for credit among commercial banks in Kenya. The study findings further established that Kenyan currency has been loosing value over one of the major foreign currencies- US$, Gross loans and advances had been increasing as well as inflation rate, Average lending rate and government domestic borrowing. The study recommends enactment of policies that control demand and supply of foreign currency to facilitate strengthening of Kenyan currency, control of lending rates while reducing inflationary pressures.