Determinants of the disparity between the central bank rate and the commercial bank prime rates in Kenya
Kiptoo, Henry C
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Efficiency in the banking sector is recognized by the Central Bank as a precondition for macroeconomic stability and is important for effective monetary policy execution. Further, a banking sector’s ability to allocate credit efficiently pegged on economic fundamentals is expected to have positive implications for economic growth. These preconditions were, however, not a solid determinant of anticipated efficiency in the Kenyan banking industry owing to unpredictability of lending-rate flexibility. Based on the aforementioned, this study sought to investigate the factors that influenced commercial bank rate adjustment disparity with what the Central Bank of Kenya would expect after variation of the Central Bank Rate and Cash Reserve Ratio. The study used secondary data which was collected from the Central Bank of Kenya and the Kenya National Bureau of Statistics, and on whose basis comparisons were made with reference to the Non-Performing Loans, Operating Costs, Industry Return on investment, and Overall Gross Domestic Product. The analysis was done using descriptive statistics and regression analysis with the aid of SPSS for Windows V.20. From the resulting regression model, non-performing loans, operating costs and industry profits had a positive influence on disparity between the central bank rate and commercial banks lending rate at 3.14, 1.75 and 2.25 unit times respectively. On the other hand, gross domestic product had little and negative influence on commercial rate adjustment. That is, an increase in gross domestic product did not significantly trigger commercial banks’ adjustment of interest rate, and if it did it was to the opposite direction. This meant that there was a significant relationship between non- Performing loans, gross domestic product, operating costs and return on investment, and the trend of disparity between the central bank rate and commercial banks lending rate in Kenya. Based on the findings, it was recommended that there was need for an interventionary move by CBK to translate the industry’s recovery effectiveness to optimal credit/loan costing and shielding of existing contracts from re-pricing. Also, despite the high target liquidity mopping indices, the pre-existing bank debtors should be insulated from unanticipated increases in order to protect their investments while sustaining their repayment abilities. While banks were encouraged to expand and provide advanced services to the public and even beyond the republic, there was little sense in allocating the financing burden to the borrowers through higher interest rates. There was need for commercial banks need to be extremely innovative by broadening their banking products so that options of enlarging lending rates far adrift the CBR were made secondary as opposed to being primary. Finally, it was recommended to the responsible authorities to bolster the country’s economic pillars which in turn would trigger the “hidden hand” industry stabilization.