Last week, there was a debate in the National Assembly on interest rates in Kenya, with MPs seeking to fix charges levied on bank customers.
Kenyan banks fix interest rates with just an SMS or e-mail notification to a customer.
With the advent of financial liberalisation, CBK governor has made deliberate efforts to regulate the country’s financial sector by streamlining interest rates, credit controls and regulating free entry into the banking sector.
Interest rates might not significantly affect the savings rate but they influence economic growth through their effect on financial deepening.
The financial sector is the backbone of any economy and it plays a crucial role in the mobilisation and allocation of resources. The main objectives of interest rate regulation should be to allocate resources efficiently, increase returns on investment and accelerate growth of the real sectors of the economy.
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The measures initiated by the National Assembly and CBK under the reform process should increase the operation efficiency of each of the constituent of the financial sector.
To achieve higher loan uptake, which increases investment rates, the Government should fix interest rate ceilings. This will lead to increase in loans uptake and investment, ultimately leading to economic growth as well as bringing down inflation.
Inasmuch as financial development in form of financial sector reforms, liberalisation and deepening is desirable, there is need to strike a balance with some level of regulation. If financial liberalisation is carried out too abruptly, it may be the main cause of destabilisation of the financial system.
In countries with imperfectly developed financial markets, the simultaneous removal of interest rate and direct credit controls as well as reserves requirements may aggravate market failure problems and lead to stagnation in financial market deepening.
Similarly, the alleviation of interest rate control in Kenya may induce more hazardous behaviour among the banks, giving them incentive to engage in excessively risky lending.
