Financial sector reforms and interest rate liberalization: The Kenya experience

For financially repressed economies, financial liberalization was expected to allow for positive real interest rates, and for stimulating the mobilization and efficient allocation of domestic financial resources. At the same time, as the market becomes competitive the costs of intermediation go down, an indication of efficiency in the intermediation of financial assets. But, for successful liberalization, prerequisites must be put in place together with proper sequencing procedures. The study explored the sequencing and actions so far taken in the liberalization process in Kenya. The study also examined the interest rate levels, spreads and determining factors, as an indicator of financial sector response to the reform process. The study found that although much had been accomplished, the financial system was characterized by repression factors including negative real interest rates, inefficiency in financial intermediation and underdeveloped financial markets. This may indicate that the economy is facing secondary financial repression. Interest rates were more responsive to the policy activities during the period than to the fundamentals. Interest rates were a monetary phenomenon with an adjustment speed of 77% to disequilibrium in the monetary sector. The study concluded that there are several loose knots that need to be tightened for the economy to experience significant positive effects of financial liberalization.