Effect Of Interest Rate Capping On Loan Default Rate Among Deposit Taking Micro Financial Institutions In Kenya

Abstract

Capping of interest rates was undertaken by the government of Kenya as a strategy to help curb the increased lending rates that were charged by commercial banks. The capping affected commercial banks while deposit taking microfinance institutions were not affected by the regulation. However, a spill-over effect was experienced by these institutions as most of the borrowers were not able to secure access of loan facilities from commercial banks since their risk profiles were higher than the potential return to the commercial banks. These individuals therefore resulted to seek borrowing in deposit taking microfinance institutions among other informal lenders who would charge arbitrary interests. This study sought to understand the effect of interest rate capping on loan default rates. A regression model was undertaken to determine the relationship between interest rate capping and loan default rate. Secondary data was collected for a period of five year (2014-2018) for each variable. The capping of interest rate variable was tested by introduction of dummy variables, 1 and 0. 1 represented the period after capping interest rate while 0 represented period prior to capping of interest rates. Other variables that were used as control variables included the management efficiency as well as loan books by the deposit taking MFIs. Full data was obtained from 9 MFI institutions, which were used in data analysis. The diagnostic test undertaken, indicated that data did not pass on normality test, while it passed on all the other tests. Non parametric tests were therefore conducted in form of spearman’s correlation and the variables were standardized by calculating the z scores for the variables. The regression model indicated a coefficient of determination of 23.9% which indicated a relatively strong model. The analysis of variance indicated that the null hypothesis should be rejected and the p value was less than alpha value that indicated that the effect was significant. The effect of interest rate capping was found to be positive with a spearman’s rho of 0.31 while management efficiency, and loan book had negative correlation. The general result findings was that there was a statistically significant effect of capping interest rates on loan default rate among the deposit taking microfinance institutions in Kenya.