Interest Rates and Financial Market Integration in West Africa Countries

Abstract

This study investigated the impact of interest rates on financial market integration in ten West African countries from 1981 to 2025, using financial market liquidity (FML) as a proxy for integration. The independent variables considered were Central Bank Policy Rates (CBPR), Prime Lending Rates (PLR), Interbank Overnight Rates (IOR), Deposit Rates (DR), and Inflation Adjusted Interest Rates (IAIR). The study adopted an ex-post facto research design and employed secondary data from the World Development Indicators and the International Monetary Fund. A panel Auto Regressive Distributed Lag approach was used to capture both short-run and long-run dynamics, accommodating variables with mixed orders of integration. Diagnostic tests, including serial correlation, heteroskedasticity, cross-sectional dependence, unit root, and Pedroni residual cointegration tests, were applied to ensure model robustness and the validity of the results. The findings indicated that Interbank Overnight Rates significantly influenced FML in both the short run (coefficient = 0.3558, p = 0.0151) and long run (coefficient = 83.6601, p = 0.0156), highlighting its central role in sustaining market liquidity and integration. Prime Lending Rates had a significant short-run positive impact on liquidity (coefficient = 0.2440, p = 0.0281) but were not significant in the long run (coefficient = -98.7652, p = 0.3552). Deposit Rates also influenced FML in the short run (coefficient = 0.3274, p = 0.0255) but were insignificant in the long run (coefficient = 27.7428, p = 0.6168). Inflation-Adjusted Interest Rates exhibited a strong short-run effect (coefficient = 0.3804, p = 0.0008) with no long-run significance (coefficient = -43.9700, p = 0.3244). Central Bank Policy Rates were statistically insignificant in both the short run (coefficient = -0.5197, p = 0.0955) and long run (coefficient = 58.0890, p = 0.4801). These results were interpreted within the frameworks of the monetary transmission mechanism, liquidity preference theory, loanable funds theory, financial integration theory, and the efficient market hypothesis. The study concluded that IOR plays a dominant role in determining both short-term and long-term financial market liquidity, while other interest rates mainly affect liquidity temporarily. Policy recommendations included enhancing interbank market operations, improving short-term liquidity responsiveness, and complementing policy rate adjustments with structural reforms to strengthen market integration. The study contributed to the understanding of how different interest rate measures affect financial market liquidity, providing insights for policymakers to design more effective monetary and financial integration strategies in the West African region.