The Effect of Interest Rate Capping on Stock Returns of Commercial Banks Listed at the Nairobi Securities Exchange

Abstract

Interest rates are among the crucial macroeconomic variables that the Central Bank may use to control variables such as inflation and investments. Interest rates are among the macroeconomic variables that influence banks’ profitability and also affect stock returns of listed commercial banks. In 2015 members of parliament made a proposal to introduce the interest rate cap. The bill was later assented by the president into law on 24th August, 2016 with the lending rate cap set at no more than four percent above the Central Bank Rate and a floor of seventy percent of the base rate set for deposits. The government can use this as a tool to uplift certain sectors in the economy but in the study caping of interest was done to restrict lenders from offering credit facilities at exploitative rates that make credit too expensive thus unaffordable. The study carried out an analysis on the 11 commercial banks listed at the Nairobi Securities Exchange over a period of 101 days with an event estimation window of +/-15 days before and after the event. Data was collected from the NSE with the NSE 25 index utilized in the study. The study shows that on the day of the announcement, the news had a significant effect on the bank stock returns as it was detrimental to the stock prices and stock returns and within 6 days after the event all banks had reflected negative CARs. Housing Finance had the most negative impact on its stock returns. T test was computed to test for 95% level of significance of the news on stock returns. The study concluded that the interest rate capping law had a negative effect on commercial bank stocks listed at the NSE. The researcher recommended the banks to construct a much diversified portfolio to ensure stability of the stock as it adjust to any new information. The government should have considered offering the banks a grace period to work out a plan to enable adjust much smoothly to the new law. Further research on interest rate capping and other stock return determinants should be studied using a model other than the market model.