Interest rate exposure represents one of the key forms of financial risk faced by banks. It has given rise to an extensive body of research, mainly focused on the estimation of sensitivity of bank stock returns to changes in interest rates. However, the analysis of the sources of bank interest rate risk has received much less attention in the literature. Studies that empirically investigate the determinants of bank interest rate exposure have traditionally used asset-liability maturity or duration gap as the key factor explaining banks‟ interest rate exposure. However, this approach presents serious drawbacks given the well-known limitations of static gap indicators, together with the difficulties to obtain precise year-by-year gap measures for most of banks. For this reason, an alternative was to examine the association between each bank‟s estimated interest rate exposure and a set of readily observable specific characteristics that might have a potentially relevant role in explaining that exposure. The aim of this research was to investigate the main determinants of the interest rate exposure of commercial banks by focusing on how total assets, off balance sheet items, bank‟s deposit and loan composition affect interest rate exposure. The research involved use of both primary and secondary data methodology. Secondary data was obtained from CBK. Primary data was collected via questionnaires from ALCO members. The research population comprised the 43 CBs operating in Kenya with a sample size of 65 respondents. The response rate for the questionnaires which were distributed was 77%. Data was analyzed using descriptive statistical approach. Data analysis was conducted through Statistical Package for Social Science (SPSS). The result was presented using charts and tables. It was established from the research findings that indeed banks total assets, customer deposits and loan composition are key determinants of bank interest rate exposure. However, there was lack of information on the off balance sheet items and thus their effect on interest rate exposure. The research recommends that CBs should in addition to traditional considerations of asset – liability maturity period take into account total assets, loan composition and customer deposits level in determining interest rates exposure. The ALCO should also encourage policies that increase savings deposits that provide cheap financing and shield the bank against interest rate exposure. The banks should ensure information and benefits of the off balance sheet income is disseminated within the banks and increase use of off balance sheet income hedge against the interest rate exposure. The commercial banks should reduce dependency on corporate deposits that attract high interest rates.
