Influence of financial deepening on economic growth in Kenya (1990-2021)

Abstract

Vision 2030 puts Kenya’s growth target at an average of 10 percent per annum. However, the country’s economic growth rate since 2009 has been an average of 4.9 percent with that of 2024 being 5.0 percent. Hence, achieving this growth target is ambitious considering that the financial deepening measures as percentage of GDP have been declining in the period 2021 to 2024. This study therefore examined the significance of financial deepening in stimulating real output within the economy over the period under study. The main objective of study was to assess the effect of financial deepening on economic growth in Kenya. The specific objectives were: to establish the effect of credit availability to the private sector, commercial bank deposits, broad money stock, lending interest rate, credit information and stock market capitalization on economic growth in Kenya. The study adopted explanatory research design that is quantitative. The study was guided by neoclassical endogenous growth theory. The major sources of data were national accounts data from the Kenya National Bureau of Statistics (KNBS) Economic Surveys, Statistical Abstracts and International Financial Statistics (IFS) site for the period 1990-2021. The study used a vector error correction model. The variables were first tested for unit root thereafter Johansen cointegration Technique was used to test the long run relationship of the variables. The study found that there were unit roots at levels but became stationary after first difference. All the assumptions of linear regression were tested and the data was found to follow normal distribution, no collinear relationship among the independent variables, data was homoscedastic and also no serial correlation found. Results showed that financial deepening variables employed had long run effects on the economic growth. Specifically, credit to private sector (β = 0.444, p < 0.05) and stock market capitalization (β = 0.148, p < 0.05) had positive and significant long-run relationship on economic growth, while commercial bank deposits (β = - 0.368, p < 0.05), broad money supply (β = -0.358 p < 0.05), depth of credit information (β = -1.715, p < 0.05) and lending interest rate (β = -0.063, p < 0.05) had negative and significant long run relationship on economic growth in Kenya. The study concluded by stating that financial deepening was key in promoting economic growth. First, the study recommends that policymakers and monetary authorities promote credit flow to productive sectors through supportive fiscal and monetary policies, including credit guarantee schemes and enhanced SME financing. Second, strengthening financial intermediation by incentivizing banks to lend for investment purposes, revising reserve requirements, and boosting efficiency is crucial. Third, the central bank should maintain prudent monetary policies to ensure liquidity growth supports output without triggering inflation. Fourth, improving credit information systems through expanded credit bureaus and transparent data-sharing will foster informed lending. Additionally, maintaining an optimal interest rate structure that encourages productive borrowing, and advancing stock market development through investor confidence, financial literacy, and technological innovation are vital for sustainable economic growth.