Effect of Interest Rate Capping on Financial Performance of Commercial Banks in Kenya

Abstract

The rate of interest is a key factor that drives the growth of the economy and bank performance. Interest rate is one of the important tools utilized by central bank of Kenya to regulate inflation and bolster economic development. Capping of interest rate is a mechanism used by government to regulate the finance sector. This study was set out to determine the effect of interest rate capping on Kenyan commercial banks’ financial performance. The study adopted a descriptive research design to establish hypothetical relationship that exists between variables as supported by Irving Fisher’s classical and approach theory that anchor this study. The populations for this study include 42 commercial banks that were operational in the study period. Monthly secondary sources of data were used for 15 months, from December, 2014 to September, 2018. This data was obtained from annual reports of CBK. Data analysis was done using descriptive statistics and paired t-test and the study found that upon capping of interest rates the performance of commercial banks declined significant as revealed by ROA. However, capital adequacy and customer deposits increased after capping of interest rates. Operational efficiency decreased by a small margin while lending rates increased greatly. Similarly, quality of loans improved moderately; this was a consequence of effective implementation of credit policies by commercial banks. It was deduced that lending rates and quality of loan demonstrated significant differences before and after capping. However, capital adequacy, operational efficiency, ROA and customer deposits revealed insignificant differences. This study recommends the need to do away with capping of interest rates. This is because, it has impacted negatively on commercial banks, as a consequence lending for private companies has deteriorated. Majority of Kenyans particularly low income earners cannot access bank lending and this has led to increased borrowing costs. The research was limited to a descriptive type of research design that establishes the nature of existing relationships amongst variables without establishing the ‘cause and effect’ relationships amongst variables. There is need to explore the long-term effects of interest rate capping and its effect on commercial banks’ financial performance to determine whether capping should be maintained or removed.