The Effect Of Interest Rates Capping On The Perfomance Of Commercial Banks In Kenya

Abstract

For a long time, interest rates in Kenya have been market determined without government intervention. Kenyan banks enjoyed higher interest rates as compared to the world average thereby making exorbitant profits. These profits were as a result of interest rate spreads where banks charged high loaning interest rates while paying low rates on savings. The legislature of Kenya intervened by introducing a law capping the maximum loaning interest rate at four points above the central bank rate (CBR) and a minimum savings interest rate at 70% of the CBR which got presidential assent in September, 2016. This move caused uncertainty on the effect that interest rate capping would have on the performance of commercial banks in the country. The objective of this research was to find out the effect of interest rate capping on the financial performance of commercial banks in Kenya with a specific focus on tier one commercial banks which dominate the sector with respect to advances and mobilized deposits. Descriptive research design was used to analyze the effect of interest rate capping on financial performance of the commercial banks. Eight tier one banks licensed by CBK were the sample of this study. Data for the study was obtained from published financial statements of the eight tier one commercial banks. Paired t-test model was used to establish whether there was significant change of banks financial performance 24 months before and 24 months after the interest rates capping law was enacted. The study established that after the interest rates capping law was implemented, the average quantity of loans given by banks has not significantly changed. The study also found out the average tier one banks liquidity has been on a decrease trend since the interest rates capping law regime. However, average banks revenue decreased for one quarter after the interest rates capping law became effective and then started increasing gradually. The study revealed that interest rate caps regulation had no significant effect on both quantity of loans given by banks and banks liquidity, therefore, interest rate caps regulation may not be the appropriate way of attaining the objective of financial access with lower long-term interest rates. The study recommends that the government of Kenya should review the interest rate capping law to eliminate interest rate caps and encourage market determined rates. The study also recommends further study to determine the long term effect of interest rates capping on the financial performance of other tier commercial banks.