The Impact of Interest Rate Capping on the Financial Performance of Commercial Banks in Kenya

Abstract

Over the centuries, Kenyan banks have enjoyed interest rates above the average world interest rates that were deemed too high and thereby slowing economic growth. The banks were viewed to be making exorbitant profits by charging high interest rates at the expense of the people in the country. This resulted to the Government of Kenya introducing interest rate capping in September 2016. The lending interest rates in the country were capped at a maximum of 4% above the Central Bank Rate while the deposit rates were capped at a minimum of 70% of the Central Bank Rate. The Central Bank Rate is periodically set by the Central Bank of Kenya. The entire economy faced uncertainty on the impact of interest rate capping on the financial performance of commercial banks in Kenya. The objective of this project was to determine the impact of the capping interest rates on the financial performance of commercial banks in Kenya. A descriptive research design was used to make an analysis of the impact of interest rate capping on the financial performance of commercial banks in Kenya. The descriptive research was coupled with content analysis. All the 42 banks in the country were the population of this project. Secondary data was used which comprised of information obtained from the financial statement of the banks. The project found out that the financial performance of banks as measured by Return of Equity was negatively affected by the introduction of capping of interest rates in the country. This is because the interest rate spreads reduced after the introduction of interest rate capping. Asset quality which is measured by Non Performing Assets ratio was found to have a negative relationship with Return on Equity and hence the higher the Non Performing Assets ratio the lower the Return on Equity. Operating efficiency as measured by operating costs to total operating income was found to have a negative relationship to Return on Equity since the higher the operating costs vis a vis the operating income, the lower the Return on Equity. The conclusion of this project is that the interest rate spread had a negative impact on the financial performance of commercial banks in Kenya. This indicates that the Government of Kenya should revise the policy on interest rate capping to ensure that the performance of banks is not negatively affected while at the same time the people in the country are not exploited by the banks. It is also recommended that the banks should introduce innovative products so as to reduce reliance on interest income and to shield themselves against the impact of lower interest rate spreads. The study also recommends that banks should explore ways of improving operating efficiency so as to remain profitable and to protect the shareholders wealth.