Monetary authority’s legitimacy is based on the underlying assumption that policy actions
are transmitted to market interest rates instantaneously, symmetrically and in a linear fashion.
However, empirical evidence suggest that commercial banks’ pricing behavior, collusion and
structure of financial system have an important bearing to transmission of policy-induced
changes to the wider economy. Using monthly time series data from June 1993 to February
2012, this study investigated these assumptions by exploring nonlinear adjustment of
commercial banks’ retail rates to monetary policy changes. Error correction model were reparameterized to capture nonlinear aspects that may influence interest rate transmission via
commercial banks in Kenya. The results revealed that adjustment towards long run equilibrium
interest rates is sluggish, speed of adjustment of commercial bank retail rates to monetary
policy changes ranges from 5 per cent per month to 15 per cent per month. Secondly,
nonlinearity was established as speed of adjustments asymmetrical across monetary policy
regimes and/or continuously time varying. The findings revealed that lending rates are rigid
downwards as they adjusted faster during expansionary monetary policy regime compared to
contractionary monetary policy regime. Third, there was evidence to suggest that nonlinearity
adjustment simultaneously time varying and regime