Relationship Between Selected Macroeconomic Variables and the Liquidity of the Banking Sector in Kenya

Abstract

Developments in the global and local financial markets especially the banking sector over the last ten years highlight the severe consequences resulting from improper management of liquidity risk especially due to the interconnectedness of these markets. A liquidity shortfall in one institution may have system-wide repercussions. To mitigate against this risk, a proper understanding of some of the factors influencing liquidity shortfalls is a crucial first step. The study’s goal was determining whether selected macroeconomic factors influence the liquidity of the Kenyan banking sector. The project’s population comprised of all the 56 banking institutions in Kenya i.e. 43 banks and 13 microfinance banks. The explanatory variables include economic growth measured by real GDP growth rate, inflation rate and exchange rate (KES/USD). The control variables were non-performing loans given by non-performing loans rate and capital adequacy given by the capital adequacy ratio. The dependent variable was liquidity given by the liquidity ratio (liquid assets to liabilities). A descriptive research design was undertaken where quarterly secondary data covering a 10-year period (from 2009 Q3 to 2019 Q2) was obtained from the CBK and KNBS for analysis. A multiple linear regression model that utilized robust standard errors was employed in analyzing how the variables relate. Data analysis was performed using Stata version 15. According to the study’s findings, the R2 figure was 0.1988 which meant that 19.88% of the variations in liquidity of banks resulted from variations in the five selected explanatory variables. The F-test revealed an F statistic which was significant at 0.05, hence the model was sufficient in explicating the variations in cash position. NPL had a positive material influence on cash position, capital adequacy and exchange rates had a positive though immaterial influence on liquidity, GDP growth and inflation had a negative and insignificant influence on liquidity. The outcomes of the study denote that the cash position of Kenya’s banking sector is more dependent on bank specific factors rather than wider economic factors that are generally outside the control of the bank. The study recommends that policy makers and banks put in place policies and measures to mitigate against the negative effects of changes in the selected macroeconomic variables as they may result in negative implications on the other core functionalities of the bank. The study also recommends that future studies focus on other macroeconomic elements that may bear a material effect on the cash position of Kenyan banks and look at other financing institutions that are becoming increasingly important in the sector such as non-deposit taking MFIs and Savings and Cooperative Societies.