Effect of Inflation and Market Structure on Interest Rates in Kenya

Abstract

The publications relating to determinants of interest rate spreads are diverse in their approaches as well as applications. The relevant publications, approaches and results range from endeavors to establish the elements that define the pure intermediation margin, to investigations that aim to pinpoint if a country’s institutional characteristics govern it. This review is considered to understand the phenomenon and gain objectivity into the most fitting perspective for Kenya. This study sought to determine the effect of inflation and market structure on interest rate spread in Kenya. The population for the study was all the 42 commercial banks operating in Kenya as at 31st December 2017. The independent variables for the study were inflation as measured by inflation rate on a quarterly basis and market structure as measured by the weighted combination of net assets, deposits and total shareholders’ funds for commercial banks in Kenya on a quarterly basis. Interest rate spread was the dependent variable and was measured by lending rate less deposit rate on a quarterly basis. Secondary data was collected for a period of 10 years (January 2008 to December 2017) on a quarterly basis. The study employed a descriptive research design and a multiple linear regression model was used to analyze the relationship between the variables. Statistical package for social sciences version 22 was used for data analysis purposes. The results of the study produced R-square value of 0.748 which means that about 74.8 percent of the variation in interest rate spread of commercial banks in Kenya can be explained by the two selected independent variables while 25.2 percent in the variation of interest rate spread was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with interest rate spread (R=0.865). ANOVA results show that the F statistic was significant at 5% level with a p=0.000. Therefore the model was fit to explain the relationship between the selected variables. The results further revealed that only market structure produced positive and statistically significant values for this study. Inflation rate was found to be statistically insignificant determinant of interest rate spread among commercial banks. This study recommended that adequate measures should be put in place to manage the market structure of commercial banks in Kenya as this significantly influences the interest rate spread.