Monetary policy and commercial banks lending rates in Kenya

Abstract

With banks being the major avenue that the CBK relies on to execute monetary policy, the paper sought to investigate whether commercial banks are actually responsive to monetary policy. The study used an Error Correctional Model to estimate a relationship where lending rates were treated as the dependent variable while the independent variables were monetary policy, specifically CBR. The model was also expanded to include additional independent variables specifically monetary policy transmission channels. These include the credit channel which is represented by credit to the private sector, exchange rate channel represented as nominal exchange rate and asset price channel. For consistency, inflation and economic growth were included in the model because these are the targets of monetary policy. The study findings showed that there was a long run relationship between lending rates and Central Bank Rate, Exchange Rates, Asset Price, Credit to the Private Sector, Economic growth and Inflation Rates. The results also indicated that CBR and Inflation cause lending rates to increase in the short run while credit to the private sector causes lending rates to decrease in the short run. A statistically significant relationship was also established between lending rates and exchange rate, CBR, credit to the private sector and inflation rates. The study also showed an insignificant relationship between lending rates and asset prices as well as economic growth in short run. The study concludes that commercial banks’ lending rates are indeed positively responsive to CBR and that CBR as an instrument of monetary policy is indeed an effective tool as it increases lending rates and relieves demand pull pressures in the economy. This could however conflict with the promotion of economic growth