Determinants of Lending Interest Rates in Deposit Taking Microfinance Institutions in Kenya

Abstract

The high interest rates charged by many deposit taking microfinance institutions have attracted the attention of policy makers throughout the world. The DTMFIs lending rate is a key indicator of the marginal cost of short-term external funding in an economy and provides useful information about developments in the average cost of borrowing. This study investigates the determinants of lending interest rates in Deposit Taking Microfinance Institution in Kenya. This study used a descriptive survey. Descriptive research design was chosen because it enabled the researcher to establish a relation between variables. The population of this study consisted of all 12 Deposit Taking Microfinance Institutions in Kenya and therefore carried out a census survey. The study used both primary and secondary data sources in gathering data for analysis. The primary data was collected using semi-structured questionnaire which had had both open and close-ended questions and was administered through drop and pick to managers, financial managers and credit officers from the DTMFIs comprising 36 respondents. The pre test was conducted to enhance clarity of the questionnaires. The collected data was thoroughly examined, summarized and tabulated. Data was coded and entered into the Statistical Package for Social Sciences (SPSS 21) for analysis.The inferential statistic regression and correlation was done. Correlation analysis was used to establish the strength of association between market structure, cost of funds and economic conditions and the lending rates in DTMFIs. The correlation was statistically significant since it had a P-Value of 0.01, 0.03 and 0.02 which is less than 0.05 and a confidence level of 95%. A linear regression model of determinants of lending rate versus DTMFIs lending rates was applied. The study established that there existed a significant positive relationship between market structure, cost of funds and economic conditions and lending rates in DTMFIs. The study concluded that market conditions factors such as competition leading to interbank rate and credit risk premium due to various risks, interest risk, credit risk, foreign exchange risk and legal risk influence lending rate in DTMFIs. Costs factors such as taxes, transactions, cost of capital, statutory reserve requirement, management fees, staff costs and that weighted average deposit rate, reserve and liquidity requirements, mandatory investment influence the lending rates in DTMFIs. The study recommended that Deposit Taking MFIs should be keen of market factors such as competitions and risks, cost of fund such as salary of the staff and management fees and inflation due to economic changes in the country when determining lending rates as there existed a positive relationship between lending rate and factor determining lending rate for the Deposit Taking MFIs.