The Role of Maturity Gaps and Short-Term Market Interest Rates on Interest Rate Risk Exposure in Commercial Banks in Kenya

Abstract

Commercial banks engage in maturity transformation and the term premium compensates them for bearing the associated duration risk. They are thus exposed to interest rate risk which is the bank's financial condition to adverse movements in interest rates and represents one of the key forms of risk that banks face as financial intermediaries. The study investigated the role of maturity gaps and short-term market interest rates on interest rate risk exposure in commercial banks in Kenya. This study adopted a panel data research design in methodology to analyze the critical interest rate risk drivers across the banking sector in Kenya. The study period covered 2005-2015. The study was informed by Expectations Hypothesis theory. Correlational research design was used and captured both cross-sectional and longitudinal dimensions of the effects of the variables under investigation that is Maturity gaps ratio (MGRs) and Interest Rate Sensitivity Ratio (IRSRs). The Interest rate risk (IRR) was expressed as a function of maturity gaps, interest rate sensitivity ratio and short-term market interest rates. STATA software was used as the tool for data manipulation. The findings indicated that that a rise in Maturity Gap 2, Maturity Gap 3, Maturity Gap 4, Maturity Gap 5, Interest Rate Sensitivity Ratio 2, Interest Rate Sensitivity Ratio 3, Interest Rate Sensitivity Ratio 4, 91DayTbill and 182DayTbill led to a decrease in the interest rate risk exposure for the commercial banks. However, an increase Maturity Gap 1, Interest Rate Sensitivity Ratio 1, Interest Rate Sensitivity Ratio 5 and 364DayTbill led to an increase in the interest rate risk exposure for the commercial banks. The study recommends that banks should have interest rate risk measurement frameworks that capture all material sources of interest rate risk and that measure the effect of interest rate changes in ways that are consistent with the scope of their activities. The assumptions underlying the system should be clearly understood by risk managers and bank management. Further, banks must establish and enforce operating limits and other practices that maintain exposures within levels consistent with their internal policies. The findings are important in formulation of policies and strategies for enhancing maturity transformation in the banking industry in the country. Keywords: Maturity Gap Ratio, Interest Rate Risk Sensitivity Ratio, Interest Rate Risk Exposure, Short-Term Market Interest Rates & Commercial Banks.