Is the Government Crowding Out the Private Sector? A Kenyan Perspective on Domestic Borrowing

We set out to investigate the impact of government domestic borrowing on private sector credit in Kenya, with a focus on whether increased holdings of government securities by commercial banks result in a crowding-out effect. Using panel data from nine Tier 1 commercial banks between 2005 and 2023, the analysis applies both fixed and random effects regression models. The Hausman test (χ² = 7.44, p = 0.114) supported the use of the random effects model. Results from the main model show that government securities held by banks have a statistically significant negative effect on private sector credit (β = –0.588, t = –3.214, p < 0.01), providing empirical support for the crowding-out hypothesis. This negative effect also holds when a one-period lag of government securities is included (β = –0.295, t = –3.725, p < 0.01), suggesting that the impact persists over time. In contrast, the alternative model using credit growth as the dependent variable reveals no statistically significant effect, indicating that government borrowing primarily affects the overall level of credit rather than short-term credit expansion. These findings imply that excessive government borrowing from the banking sector may restrict credit availability to the private sector, with potential implications for private investment and economic growth. Our findings have both policy and practical implications. We recommend that the government should diversify its sources of financing and avoid over-reliance on bank borrowing. The Central Bank of Kenya should also promote balanced credit allocation through regulatory incentives and coordinated fiscal-monetary policies.