Testing Efficiency and Segmentation of the Interbank Money Market in Kenya

Abstract

In this study, the researcher has tested efficiency and segmentation of the interbank money market in Kenya. The study has analyzed all the 44 banks that trade in the interbank money market in Kenya. The study utilizes network framework and case studies of countries with developed interbank money market namely the UK, EU and the US. In determining segmentation of the interbank money market, the research has analysed lending relationship between banks of different sizes by the intensity of the lender and borrower activity i.e. BPI and LPI.The research has analysed the rate of interest charged to different categories of banks in a particular period to test for convergence of interest rates. In testing for the efficiency of the interbank money market the research has tested the ability of the interbank money market to channel liquidity in the market, how the interbank money market responds to other policy rates in the market i.e. the CBR, CRR and the 90 days treasury bills. The researcher used data for the period January 2009 to December 2013 to analyze and make conclusions as per the objective of the research. The study finds that Kenya interbank money market is incomplete and highly segmented by large, medium and small banks. Large banks discriminate small and medium size banks in terms of credit extended and interest rates charged, which is usually higher than those charged to their peers, this limits the market to function effectively. The study has concluded that though the interbank money market is highly segmented it is relatively efficient as it‟s able to channel liquidity to the market and also it responds to the policy rates which are aimed at regulating the liquidity position in the market. The interbank market rate influence the pricing of other products in banks i.e. deposits and lending rates, this proves that the interbank market is performing its role of price discovery.