Central Bank Rate Pass-Through Effects on Kenya’s Lending Rate

Abstract

Several African nations, including Kenya, Nigeria, and South Africa, have seen dramatic shifts in their monetary policy framework and financial environment during the last two decades. To manage and stabilize the economy, the Central Bank of Kenya (CBK) stopped intervening directly in lending low interest rates at financial institutions and instead turned to indirect and market-based measures to carry out monetary policy. Even though it was predictable that a changing financial environment would have a substantial impact on the efficacy of monetary policies, there has not been sufficient research done to determine how IRPT affects lending rates. The purpose of this article was to analyze the pass-through effects of the central bank rate on lending rates in Kenya. The study adopted a non-experimental research design. Data was collected from the CBK, the Kenya Bureau of National Statistics, and the Nairobi Stock Exchange between 2010 and 2021 quarterly data. The study's theoretical underpinning was the loanable funds theory and cost of capital. The cost-of-funds method is based on the conventional marginal cost pricing model for financial markets and helps explain how market prices are transmitted to consumers. The error correction model was used to measure the short-term effect of bank rate changes on Kenyan lending rates. The findings showed that Kenya has an incomplete IRPT which means that increases in the lending rate would be less than proportional whenever there is a change of a specific percentage in the CBR. According to the study, this may be one of the causes of some banks' foreign ownership, their independence from the central bank's liquidity, and their slow reaction times to signals from the central bank to modify lending rates. The study recommends that since commercial banks are a very important component in the transmission mechanisms, they should follow suit in the adjustment of the lending rates.