The Effect of Market Liquidity Dimensions on the Use of Financial Derivatives in Interest Rate Risk Management among Commercial Banks in Kenya.

Abstract

Capital Markets are undertaking the ongoing rollout of Derivatives/commodities Futures Exchange to provide more financial products to facilitate growth in the Kenyan economy. Hopefully, commercial banks will manage their exposures on the bond market with highly leveraged balance sheets and high interest rate risk exposures. Price behavior and market viability depend on the trading mechanism to match sellers and buyers ‘trading desires, and this matching process involves providing market liquidity. Bond markets structuring include bond dealers and electronic exchanges like Reuters, Bloomberg and Citivelocity. The objective of this research was to establish market makers' perceptions of the effects of market liquidity parameters on interest rate risk management using financial derivatives in Kenya. Specifically, the study established the effect of market immediacy towards the Interest Rate risk management with Financial Derivatives; determined market depth effect on the Interest Rate risk management with Financial Derivatives, determined market breadth effect on the Interest Rate risk management with Financial Derivatives, and assessed market resiliency effect on the Internet Rate risk management with Financial Derivatives in Kenyan commercial banks. This research incorporated a descriptive research design. The target population comprised of 44 commercial banks in Kenya. The study gathered data from 108 market makers from 39 commercial banks using email or drop-and-pick method questionnaires. The analysis of data was undertaken using descriptive (percentages, frequencies and means) as well as inferential statistics such as Pearson correlation and also regression analysis. The study’s findings reveal that in managing interest rate risk using financial derivatives, market resilience and market breadth were more important. According to the study, market immediacy and interest rate risk management using financial derivatives, were positively associated. The depth and breadth of the market have a positive and significant effect on the management of interest rate risks using financial Derivatives. Market resiliency had an insignificant positive effect on the use of financial Derivatives on interest rate risk management. There is a positive correlation between market tightness and risk management of interest rates using financial derivatives. The study recommends that Kenya's commercial banks should increase their active participation in the market for interest rate derivatives as the results of the study have shown a huge presence of market makers. The government should consider strengthening the market makers system in the country. The study also recommends that market manufacturers in commercial banks need to increase the use electronic trading platforms such as Bloomberg and Citivelocity to provide core services to support the real economy.