Monetary Policy and Financial Performance of Commercial Banks in Kigali, Rwanda

ABSTRACT This study investigated the effect of monetary policy on the financial performance of commercial banks in Rwanda. The following objectives guided the study: i) to evaluate the effect of Central Bank’s open market operations on the financial performance of Commercial Banks in Rwanda; ii) to examine the effect of Central Bank Rate (CBR) on the financial performance of Commercial Banks in Rwanda; and iii) to investigate the effect of Reserve Requirement ratio on the financiL~ performance of Commercial Banks in Rwanda. The study adopted cx post facto research design. The data source was fi~orn annual report publications by the National Bank of Rwanda. Data was analysed using multiple regression model. The study found no significant effect of Central Bank’s Open Market Operations on the financial performance of commercial banks in Rwanda (p=O.200>O.05). Similarly, the study found no significant effect of the central bank iate on the financial performance (Return on Assets) of commercial banks in Rwanda (p=O.53 1>0.05). In addition, the study found no significant effect of reserve requirement ratio on the financial performance (return on assets) of commercial banks in Rwanda (p0.605>0.05).The study concluded that monetary policy has no significant effect on return of assets of commercial banks in Rwa1~J~~ The study made the following recommendations: the need for commercial banks not to keep excess reserve on which they can draw in the event of a restrictive monetary policy because it affects open market operations, the need for the monetary authorities to make efforts towards having a relative stability in the level of interest rate and the need for the central bank of Rwanda to make reserve requirement ratio a major fulcrum on which monetary policy would be based in order to improve the effectiveness of the monetary policy on the commercial banks.

TABLE OF CONTENTS

LISTS

DECLARATION

APPROVAL

DEDICATION

ACKNOWLEDGEMENTS

OF ABBREVIATIONS

.

LIST OFTABLES

ABSTRACT

CHAPTER ONE 1

INTRODUCTION 1

1.1 Background ofthe Study 1

1.1 .1 Historical Perspective 1

1.1 .2 Theoretical Perspective 4

1.1 .3 Conceptual Perspective 5

.1.4 Contextual Perspective s

1.2 Statement ofthe Problem 6

1.3 Purpose ofthe Study 7

1.4 Objectives ofthe Study 7

1 .5 Research Questions

1 .6 Hypotheses 8

1.7 Scope ofthe Study 8

1.7.1 Geographical Scope 8

1.7.2 Theoretical Scope 8

1.7.3 Content Scope 8

1.7.4 Time Scope 9

1.8 Significance ofthe Study 9

1.9 Operational Definition of Terms g

CHAPTER TWO 11

LITERATURE REVIEW 11

2.0 Introduction 11

2.1 Theoretical Review 11

2.1.1 LoanableFundsTheory 11

2.1.2 Credit Market Theory 12

vi’

2.1.3 New Keynes Model.13

2.2 Conceptual framework 15

2.3 Review of Empirical Studies 15

2.3.1 Monetary Policy 15

2.3.2 Financial Performance 18

2.3.2.1 Return on Assets 23

2.3.3The Effect of Open Market Operation (OMO) on the Financial Performance of Commercial

Banks 24

2.3.4 The Effect ofthe Central Bank Rate on Financial Performance of Commercial Banks 26

2.3.5 The Effect of Reserve Requirement Ratio on the Financial Performance of Commercial Banks27

2.6 Related Studies 28

2.7 Gaps ofthe Study 34

CHAPTER THREE 36

METHODOLOGY 36

3.0 Introduction 36

3.1 Research Design 36

3.2 Model Specification 37

3.3 Data Sources 38

3.4 Data Analysis 38

3.5 Ethical Considerations 38

3.6 Limitation ofthe Study 39

CHAPTER FOUR 4o

DATA PRESENTATION, ANALYSIS AND INTERPRETATION 40

4.0 Introduction 40

4.1 Unit Root test 40

4.2 The Effect of Central Bank’s Open Market Operations on the Financial Performance of

Commercial Banks in Rwanda 41

4.3 The Effect of Central Bank Rate (CBR) on the Financial Performance of Commercial Banks in

Rwanda 42

4.4 The Effect of Reserve Requirement Ratio on the Financial Performance of Commercial Banks in

Rwanda 43

CHAPTER FIVE 45

DISCUSSION, CONCLUSION AND RECOMMENDATION 45

5.1 Discussion 45

VIII

5.1.1 The Effect of Central Bank’s Open Market Operations on the Financial Performance of

Commercial Banks in Rwanda 45

5.1.2 The Effect of Central Bank Rate (CBR) on the Financial Performance of Commercial Banks in

Rwanda 46

5.1.3 The Effect of Reserve Requirement Ratio on the Financial Performance of Commercial Banks in

Rwanda 47

5.2 Conclusion 48

5.3 Recommendations 49

5.4 Areas for Future Studies 50

5.5 Contribution to Knowledge 50

References 51

APPENDIX 1: DATA 60