The responsiveness of bank deposit interest rates to policy rate changes in the Kenyan Commercial Banks

Submitted in partial fulfillment of the requirements for the Degree of Master of Commerce at Strathmore UniversityThe Central Bank maintains price stability in the economy by managing the interest rate changes in the economy through monetary policy measures. It expects the interest rates to adjust in response to policy rate changes but mixed findings of interest rate adjustment have been observed despite the importance vested in the transmission process. Therefore, this study examined the responsiveness of deposit interest rates as the benchmark policy rate changed in the Kenyan commercial banks. It explained the monetary policy transmission process from the policy rate to the retail deposit interest rates. The study used various econometric tests and key among them where the granger causality test and error correction model (ECM). The granger causality test measured whether the benchmark policy rate caused the adjustment of deposit interest rates while ECM measured interest rate pass-through and the adjustment behavior. The results strongly indicated that the benchmark policy rate (T-bill) influenced the adjustment of deposit interest rates. Using both symmetric and asymmetric ECM, incomplete pass-through was found on the deposit rates both in the short-run and long-run. Mixed results of asymmetric adjustment of deposit interest rates were established. In the entire period (1991-2013) and first period (1991-2003) deposit interest rates were observed to adjust rigidly upwards and quickly downwards supporting the collusive pricing arrangement behavior. In the second period (2004-2013), deposit interest rates adjusted quickly upwards and rigidly downwards supporting the negative customer reactions behavior. The symmetric Mean Adjustment Lag (MAL) indicated that it took between 5 and 27 months for the deposit interest rates to fully adjust as the policy rate adjusted. The deposit interest rate rigidity from the findings, implied that monetary policy was not effective and therefore not achieving its intended objectives