Interbank Market Discipline and its Effectiveness: Lessons from Developing Markets

This study explores interbank market discipline and its effectiveness in Kenya and Malawi by examining the factors that drive the quantity- and price-based measures of market discipline, and the effectiveness of disciplinary mechanisms in influencing commercial banks’ capital adequacy ratios. The findings show the differentiating effects that bank risk factors have on interbank volumes and rates in the two countries, and while both quantity- and price-based discipline mechanisms are effective in Kenya, only the price-based discipline is effective in Malawi. The study recommends a review of the rules of engagement in the interbank market targeted at reducing the influence of some banks in the Malawi interbank market. For both countries, policy makers could tighten rules for banks’ liquidity management so that deviations are more heavily penalized and banks would be highly incentivized to increase their capital adequacy ratios, in support of prudential regulation and the objectives of monetary policy.