Effect of Interest Rate Capping On Performance of Commercial Banks in Kenya

Abstract

The purpose of the study is to examine the effects of interest rate capping on performance of commercial banks in Kenya. The key objectives of the study were to analyse the effect of interest rate capping on the profitability of commercial banks in Kenya; investigate the effect of interest rate capping on credit uptake; and analyse the relationship between interest rate capping and lending patterns in commercial banks in Kenya. A descriptive research design was adopted to explain the nature of the relationship between interest rate capping and performance of commercial banks in Kenya. The target population for the study included 44 licensed commercial banks in Kenya. The calculated sample size for the study includes 39 commercial banks in Kenya. The researcher compiled all the relevant annual financial reports of all the listed commercial bank. A critical analysis led to the selection of the data pertaining to the performance, loan accessibility and profitability of all the listed commercial banks. Some of the data was obtained from the Central Bank of Kenya database. Simple random sampling was utilized to select the commercial banks as the representatives for the study. Statically Package for Social Sciences (SPSS) was used to code and analyze the compiled data. In the study, both descriptive and inferential statistics were used. Descriptive statistics were in terms of graphs, frequency tables and chart, while inferential statistics were in terms of linear regression, ANOVA and correlation analyses.

The findings show that commercial banks in Kenya comprise public commercial banks (8%), private commercial banks (55%) and foreign banks (38%). The total net assets in the commercial banks stood at Kshs 4.0 trillion by December 31, 2017. The local private banks make up for 64.8% of the total assets in the commercial banking sector. Public commercial banks make up 3.5% of the total net assets in the commercial bank sector. The overall efficiency in the commercial bank is considered high as indicated by the overall net assets the level of technology application to facilitate service delivery. In terms of performance, the results reveal that the overall performance in the banking sector declined by 9.6% in 2017. The decline was recorded in pre-tax profits. The decline in the profitability of commercial banks was associated with the reduction income and not an increase in expenses. The impact was heavy on smaller banks that experienced accelerated decline in profitability after the introduction of the interest rate cap. Tier III commercial banks experienced difficulties in building capital and retaining income flow. There is a significant weak positive relationship between interest rate and the overall profitability of commercial banks. This explains why the introduction of interest rate caps led to a decline in income.

The results further show that there was an increase in the average size of loans offered by commercial banks in Kenya. This implies that banks preferred lending to entities with fewer risks. A positive significant relationship between interest rate and credit uptake was established via regression analysis. Other than the risk profile of a client, there are other factors that influence the decision to offer loans to a client in commercial banks. The ratio of performing and non-performing loans is one of the indicators used to determine the number of loans that a bank can offer. In a bid to cushion themselves from risky loans, banks use high interest rates as one of the control measures. This seeks to explain why after the introduction of interest rate capping the credit market settled for secured short term or loans to the well-established corporate institutions. This was because of the heightened sensitivity to risks and non-performing loans. According to the findings of the study, there was a positive significant relationship between interest rate and the lending patterns of commercial banks. Interest rates is a driving factor when offering loans, which means with high interest rates banks will tend to offer more loans. The average lending patterns in the Kenyan commercial banks sector remained average after the introduction of the interest rate cap. On the same note, there was an increase in the deposit rate after the introduction of the interest rate cap law.

The study recommended that the Central Bank of Kenya should use alternative ways to solve the issue of money supply because the introduction of interest rate cap stifles the growth of commercial banks. Commercial banks are encouraged to expand their sources of income to avoid over reliance on interest rates as the source of income. It will make it easy for commercial banks to cope with the changes in laws that affect interest rates. There should be a framework that guides lending patterns with aim of protecting the interests of both commercial banks and clients.