Market structure, macro economic shocks and banking risk in Kenya

Abstract

Abstract Changing market structure in the banking sector following nancial liberalization and macroeco- nomic shocks have the potential to adversely impact banking risk exposure. This research paper investigates the e ect of these factors on the risk exposure of commercial banks in Kenya. It is argued that competition resulting from nancial liberalization and the impact of macroeconomic shocks may increase bank risk taking incentives and risk exposure. Speci cally, it is hypothesized that nancial liberalization increases banking fragility by reducing franchise value which induces risk taking and that positive and negative macroeconomic shocks increase banking risk exposure. Annual bank nancial performance panel data for the period 2008 to 2013 is used to analyse the impact of market structure and macroeconomic variables on borrowing and lending risk exposure using GMM estimation. The results indicate that there is some support for both hypotheses. Borrowing risk exposure was found not to be persistent, being mainly a ected by the degree of concentration and external economic shocks. Interestingly, the results also suggest that changes in the short-term interest rate do not a ect the net interest margin; which may imply that bank deposit and lending rates are rigid and that the interest rate channel is ine ective. Lending risk exposure was found to be persistent, being mainly a ected by the degree of concentration, internal economic shocks and external economic shocks. Further analysis of the factors contributing to the persistence of lending risk exposure using a PVAR model found that the banks' loan growth rate and the market interest rate were the key determinants; though the impact of the loan growth rate was about double the impact of interest rate risk, implying that bank risk taking is the key determinant of the persistence of lending risk exposure. Keywords: Market structure, macroeconomic shocks, macro- nancial linkages, banking risk, dy- namic panel data