Effect of the Prevailing Lending Interest Rates on the Default Rate of Kenyan Deposit Taking Microfinance Banks

Abstract

In a short term, low interest rates minimize credit risk since refinancing costs are lowered and the net worth of borrowers is increased, which decreases credit risk of outstanding bank loans. Because of the number of outstanding loans being higher in comparison of that of new loans, the low interest rates therefore only make the portfolio less risky only in the short term. The objective of the study was to establish the effect of the lending interest rate on the default rate of Kenyan Micro-Finance Institutions. In addition it is focused on review of the growing empirical and theoretical studies which have endeavoured to examine the range of magnitude and effects of lending interest rates on the default rate of Micro-Finance Institutions. The target population was all the 13 licensed MFIs. 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 lending interest rates and by extension the control variables, collateral and derivatives, and the default rates of MFIs. The study findings were that lending interest rates have a significant association and relationship with default rate. Lending interest rate has a significant negative relationship with default rate. The study made recommendations to policy makers like the National Treasury and CBK to regulate the interest rates in order to mitigate default rates. Recommendations were also made to MFIs, and by extension, other financial institutions, to utilize interest rates in order to mitigate default rates by customers. Further recommendations were that particular focus should be made on the lending interest rates in order to mitigate default rates.