The Impact of Financial Innovation on Monetary Sector Policy in Kenya

Abstract

The study examined the relationship between financial innovation and monetary sector development in Kenya using Generalized Method of Moments (GMM) approach based on Ordinary Least Squares (OLS) technique and time series annual data over the period between 2000 and 2017. The GMM version is superior over OLS technique because it allows adjustment of long-term variation between financial innovation and macroeconomic development. Financial innovation is measured by five indexes: currency-money (CM) ratio, e-money (EM), intermediation ratio (IR), financial ratio (FR), and e-payment (EP). Monetary policy development is measured by seven indicators, namely: real GDP, money supply (MS3), domestic credit (DC), interest rates, inflation rate, exchange rate, and stock market development. Based on the empirical results, evidence shows that financial innovation (i.e. EM, IR, FR, and EP) had significant impact on monetary sector development. Rapid innovation as a phenomenon in the past decades has changed the array of financial services available to customers and increased the efficiency of the financial sector (or system), but at the same time, complicated the environment in which Central Bank of Kenya (CBK) implements its monetary policies. This study was important for the purpose of combating the implications associated with the future development of these innovations in the financial system and the conduct of monetary policy. Also, the CBK) should be able to conduct a monetary policy process based on the changing financial environment by implementing essential reforms and critical forward-looking policies for a sustainable financial development and economy.