Discussion Paper No. 122 of 2010 on Efficiency of the Financial Market Intermediation Process in Kenya: A Comparative Analysis

Abstract

Interest rate margins have been used severally in literature to indicate the extent of financial sector repression and inefficiency. Wide interest margins are detrimental for savings mobilization and stifle investment growth. Wide interest margins, as witnessed in Kenya, are a sign of a repressed and inefficient financial sector. This study analyzes the determinants of the efficiency of the financial sector intermediation process in 11 countries, with a view to recommending policy options for reducing the spreads and improving the financial market efficiency in Kenya, in line with the findings from other countries. The study estimates a fixed-effect, Seemingly Unrelated (SUR) regression model using panel cointegration technique. The findings show that the major contributor to the widening interest rate margins in Kenya, leading to inefficient intermediation process are: high operating costs, poor asset quality and a concentrated banking sector. The findings call for measures that will further reduce the non-performing loan portfolios, increase competition in the banking industry and reduce operating costs as well as improve the efficiency of the capital markets (Nairobi Stock Exchange).