The relationship between interest rates and profitability of commercial banks in Kenya

Abstract

Interest rates in the recent past have become a very sensitive factor in the operation of commercial banks. The central bank of Kenya has used it as a tool to control the inflation levels and also to manage the foreign exchange rates to acquire stability in the economy. With these happenings the commercial banks have had to contend with periods of high interest rates which have affected the banks differently as different banks react differently to the impact of interest rate changes. This changes cause consumers to reduce their borrowings or halt them with the expectations that interest rates will eventually come down. Since one of the major sources of income for commercial banks is earned from interest related activities it is of paramount importance that the commercial banks understand the impact of interest rates on their productivity in order to maximize shareholders wealth. The objective of this study was to find out the relationship between interest rates and the profitability of commercial banks in Kenya .The study adopted a regression research design which involved determining profitability when interest rate is varied at different times to determine its effects on profit levels . A censure study was done by collecting data from all the 43 commercial banks in Kenya .The type of data collected was secondary data from their annual financial statements for the last 3 years and the commercial bank rates got from Central bank of Kenya . Regression analysis was applied to analyze the data with graphs, charts to determine the impact of interest rates on banks profitability The research found out that on overall, there is positive relationship between interest rate changes and profitability of banks. As interest rate increases , profits of banks also increases This could be as a result of ability of banks to diversify their products to take care of the changing operating environment and their ability to tap in the fortunes brought about by increased interest rate by investing in high yielding treasury bills and diversification of funds. This study shows that the banks have come up with measures to take care of changes in interest rates so as not to affect them too badly although there is a reduction in the profit levels of some banks. A study should be further done to establish what other policies can the policy makers use to tame inflation and stabilize the economy other than controlling interest rates as the banks have come up with ways of managing the interest rates and the policy makers may not be able to achieve the desired objective in controlling the interest rates