The Effect of Selected Interest Rate Determinants on the Quality of Credit Portfolio Offered by Listed Commercial Banks in Kenya

Abstract

Commercial banks' capacity to advance sustainable loans to their clients depends on the quality of their credit portfolio. While monitoring the quality of a commercial bank's credit portfolio continues to be challenging, the performance of most commercial banks globally depends on how well they manage their biggest asset-loans. The quality of the credit portfolio that commercial banks offer is influenced by factors such as interest rates. The objective of the study was to determine the effect of selected interest rate determinants on the quality of credit portfolio offered by listed commercial banks in Kenya. The study used the cost of borrowing, capital adequacy and BOPO (operating cost to income ratio) as the independent variable while credit portfolio quality as the dependent variable. The study employed descriptive research design to establish if there is a statistical link or correlation between variables with little or no effort to control extraneous variables. Twelve listed commercial banks formed the population sample, but data was only available for 11 banks. Correlation analysis revealed a positive and strong correlation between the operational cost to income (BOPO) and credit portfolio quality. At the same time, the findings indicated a strong negative correlation between capital adequacy and credit portfolio quality. Interest rate (cost of borrowing) had a positive but weak correlation with the quality of the credit portfolio. The regression results show that interest rates have no significant effect on the credit portfolio quality, while BOPO and capital adequacy significantly affect the credit portfolio quality. BOPO and capital adequacy also exhibited positive and negative relationships with the credit portfolio quality, respectively. The findings also indicated that the independent variables explained 51.5% of variations in the quality of the credit portfolio. The regression model was also fit since the p-value was 0.00. It is therefore recommended that banks raise their core capital base since the capital adequacy measure revealed that banks with high capital improve the quality of their credit portfolio. Further, banks need to maximize operating income to keep their BOPO ratio within manageable limits.