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Interest rate risk in Kenya: The banking sector stability and fiscal risks nexus

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  • Talam, Camilla
  • Kiemo, Samuel

Abstract

The study sought to examine the effect interest rate risks on banking sector stability through disentangling the effect of interest rate risk on both fiscal and banking sector stability conditions in Kenya. We applied annual macroeconomic and bank-level data for the period 2001 - 2022 across 37 banks. The study also developed a banking sector stability index to examine evolution of banking sector stability , undertook sensitivity analysis on interest rate sensitive assets k and applied panel fixed effects model to examine the effect of interest rate and fiscal policy risks on banking sector stability . The study found that overall, the banking sector has remained resilient over the study periods, despite experiencing some periods of financial instability. The study also found monetary policy stance has implications on fiscal and banking sector stability whereby contractionary monetary policy raises fiscal and banking sector stability risks when public debt is elevated due to a tight sovereign-bank nexus. Increases in interest rate and credit risks were found to lower banking sector stability while bank capital accumulation strengthened banking sector stability . A high sovereign-bank nexus increases banking sector stability through repricing risks reflected via interest rate and liquidity risks. On other hand banks' portfolio diversification and trading strategies help to mitigate and lower repricing risks from market and interest rate changes. The paper proposes tracking of sovereign-bank nexus overtime to cover multiple business cycles to enhance understanding of sovereign-bank nexus dynamics towards coordinating monetary, fiscal and macroprudential policies.

Suggested Citation

  • Talam, Camilla & Kiemo, Samuel, 2024. "Interest rate risk in Kenya: The banking sector stability and fiscal risks nexus," KBA Centre for Research on Financial Markets and Policy Working Paper Series 80, Kenya Bankers Association (KBA).
    • Handle: RePEc:zbw:kbawps:297989
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    References listed on IDEAS

    as
    1. Samuel Kiemo (PhD) & Cyrus Mugo, 2021. "Banking Sector Consolidation and Stability in Kenya," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 11(3), pages 1-6.
    2. El-Erian, M. A., 2012. "When Western sovereign risk is in play," Financial Stability Review, Banque de France, issue 16, pages 29-36, April.
    3. Samuel Kiemo & Anne Kamau, 2021. "Banking sector competition and intermediation efficiency in Kenya," African Development Review, African Development Bank, vol. 33(4), pages 648-661, December.
    4. Harlan Platt & Marjorie Platt, 2002. "Predicting corporate financial distress: Reflections on choice-based sample bias," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 26(2), pages 184-199, June.
    5. Michael Davies & Tim Ng, 2011. "The rise of sovereign credit risk: implications for financial stability," BIS Quarterly Review, Bank for International Settlements, September.
    6. Feyen,Erik H.B. & Zuccardi,Igor, 2019. "The Sovereign-Bank Nexus in EMDEs : What Is It, Is It Rising, and What Are the Policy Implications ?," Policy Research Working Paper Series 8950, The World Bank.
    7. Dell'Ariccia, Giovanni & Ferreira, Caio & Jenkinson, Nigel & Laeven, Luc & Martin, Alberto & Minoiu, Camelia & Popov, Alexander, 2018. "Managing the sovereign-bank nexus," Working Paper Series 2177, European Central Bank.
    8. Andrea Deghi & Mr. Salih Fendoglu & Tara Iyer & Mr. Hamid R Tabarraei & Yizhi Xu & Mustafa Yenice, 2022. "The Sovereign-Bank Nexus in Emerging Markets in the Wake of the COVID-19 Pandemic," IMF Working Papers 2022/223, International Monetary Fund.
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    Keywords

    Banking sector stability; Fiscal Risks; Monetary policy;
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