| dc.description.abstract | Changes in banks' competitive environment, products, and services have heightened the
importance of prudent interest rate risk management. Historically, the interest rate
environment for banks has been fairly stable. More recently, interest rates have become
more volatile, and banks have arguably become more exposed to such volatility because
of the changing character of their liabilities.
Each year, the financial products offered and purchased by banks become more various
and complex and many of these products pose risk to the banks. Many commercial
banks have increased their holdings of long-term assets and liabilities, whose values are
more sensitive to interest rate changes. Such changes mean that managing interest rate
risk is far more important and complex than it has been in the past.
This study set out to determine the relationship between interest rate risk and net interest
income of commercial banks in Kenya. Net interest income observed for 5-year period
was regressed against interest rate risk in each year. Interest rate risk was measured as
the interest rate sensitivity gap between assets and liabilities maturing/repricing in time bands
of less than three months, between three and twelve months and maturities in
periods above one year. These three categories formed the independent variables for use
in the study. The study found that there is a strong direct relationship between interest
rate risk and net interest income of commercial banks. Specifically, interest rate
sensitivity gap movements account for 58.0% of variations in net interest income.
Each of the three categories of interest rate sensitivity gap was found to positively
contribute to net interest income. A unit increase in short term sensitivity gap
(maturities in less than three months) results in 0.141 units increase in net interest
income, while a unit increase in medium term sensitivity gap (maturities in between
three and twelve months) results in 0.426 units increase net interest income. The study
also found that a unit increase in long term sensitivity gap (maturities in periods above
one year) results in 0.176 units increase in net interest income.
These results imply that proper interest rate risk management not only reduces a bank's
exposure to the risk, but it also provides banks with an opportunity to stabilize and
improve their net interest income. Overall, net interest income is increased by
maintaining high positive medium term sensitivity gaps in an increasing interest rate
environment and low negative medium term sensitivity gaps in a declining interest rate
environment. | en |
