The effect of interest rates capping on the interest rate spread of commercial banks in Kenya

Abstract

The capping of the interest rate has resulted to the commercial banks having a poor financial performance (Aurello, 2015). Following interest rate, capping notable losses or rather drop in profit has been reported in various countries around the globe by banks. In fact, the adverse effect brought about by interest rate capping on the commercial banks performance has seen banks withdrawing and also closing some of their branches in different region across the world. Banks have chosen to reduce their cost since the interest capping has had an impact on their revenue in the corresponding countries. The “objective of the study was to determine the influence of interest rate capping on interest rate spreads realized by Kenyan commercial banks. It also aimed at reviewing the increasing body of theoretical and empirical studies that have endeavored to examine the range of magnitude and effects of the interest rate capping on interest rate spreads of commercial banks. The target population was all the 42 licensed commercial” banks. Secondary sources of data were employed. Panel data was utilized, data was collected for several units of analysis over a varying time periods. The research “employed inferential statistics, which included correlation analysis and panel multiple linear regression equation with the technique of estimation being Ordinary Least Squares (OLS) so as to establish the relationship of the bank specific factors and sharia compliance, and the financial performance of commercial banks and also to establish the effect of interest rate capping on interest rate spreads of commercial banks. The study findings were that interest rate capping, NPL, management efficiency, and bank size have a significant association with interest rate spreads. Interest rate capping, credit risk, management efficiency have a negative significant association with interest rate spreads. Bank size has a positive significant association with interest rate spreads. Leverage however, does not have a significant association with interest rate spreads. Additionally, the study findings revealed that interest rate capping and the bank specific factors do significantly influence interest rate spreads. Thus, they can be utilized to significantly predict the interest rate spreads of commercial banks. The study findings also exhibited that only interest rate capping and bank size had significant relationships with interest rate spreads. Interest rate capping has a significant negative influence on interest rate spreads whereas bank size has a significant negative influence on interest rate spreads. Credit risk, management efficiency, and levearage however do not have significant effects on interest rate spreads. Final findings were that there was a significant change in the interest rate spread of the commercial banks from before the interest rate capping legislation was enacted and after it was enacted. Policy recommendations are made to the National Treasury and CBK to institute interest capping because it reduces the interest rate spread which has been higher than the African average. Additionally, the regulator, the CBK, can utilize the CAMEL framework, which mainly entails the bank specific factors, to gauge the performance and going concern status of the individual banks. Recommendation were made to the commercial bank practitioners, and by extension other financial institutions xiv practitioners and consultants to employ other strategies to lower the cost of funds in case of an interest rate capping regime because the lending rate is fixed. Further recommendations were made to them to” increase bank size in order to augment the financial institutions’ financial performance.