Exchange rate, diaspora remittance and banking sector development in Kenya

Abstract

Banking sector development portents numerous benefits to a nation in as far as harnessing diaspora remittance is concerned. Kenya is considered a developing economy and diaspora remittance has turned out to be one key capital inflow contributing to 4% of the total GDP. However, the banking sector in Kenya is not well developed enough due to the exchange rate regime that is prone to enormous exchange rate variability. This makes it hard to harness diaspora remittance which has turned out to be one of Kenya’s foreign capital inflows. Stakeholders concur with the decisiveness and urgency to have the banking sector developed to help it tap diaspora remittance, which is a vital foreign cash inflow. The objectives of the study included; to assess the effect of exchange rate on banking sector development in Kenya, to determine the effect of exchange rate on diaspora remittance in Kenya, to assess the effect of diaspora remittance on banking sector development in Kenya, and to establish the mediating effect of diaspora remittance on the effect of the exchange rate and banking sector development in Kenya. The theories that guided the study were; The Financial Liberalization Theory, Pure Altruism Theory, and Pure Self-Interest. The explanatory research design was used in this study. Secondary data was sourced from the World Bank between 1983 and 2018. The Augmented Dickey-Fuller (ADF) and Philip Perron tests were utilized to test the stationary of the variables. The results established that exchange rates (p − value 0.00 < 0.05) have a significant effect on banking sector development. Similarly, the exchange rate (p − value 0.021 < 0.05) has a significant effect on diaspora remittance. Further, diaspora remittance (p − value 0.001 < 0.05) has a significant effect on banking sector development. The Sobel test was used to test for mediation and the results ( p − value 0.0304 < 0.05, Z 2.1637 > 1.96 ) showed that diaspora remittance partially mediates the effect of exchange rates on banking sector development. The study has crucial implications to both theory and practice of finance and macroeconomics. The study contributes to the understanding that exchange rates affect the banking sector through the interplay of diaspora remittance. In addition the study promotes the understanding that exchange rate as a microeconomic variable, and diaspora remittance are important in trying to understand how to develop the banking sector. The study contributes to the theory of financial liberalization that foreign capital inflows, primarily, diaspora remittance is quite significant in influencing banking sector development. The study recommends the need for the government to develop policies that curtail transaction costs, that encourage diversification of economic activities and that provide incentives for value addition, especially for agricultural exports.