Effect of interest rates on non-performing loans in Commercial Banks In Kenya

Abstract

Lending money is the main traditional function of commercial banks, and this aspect of banking remains to date. However, loan defaults among commercials banks remain high leading to financial distress of the banks even eventual collapse. Interest rate has an inherent implicit cost on the credit issued by banks with antecedent implication on loan defaults. Thus, the study sought to establish the impact of interest rates on nonperforming loans in commercial banks in Kenya. This study adopted a descriptive research design targeting all the 43 licensed commercial banks in Kenya. Secondary data was collected on the interest rate charged by the banks, total loan and advances, total non-performing loans, total assets, total risk weighted assets, noninterest expense, total revenue for five-year period (2009 – 2013). The data collected was analyzed using both descriptive and inferential statistics from multiple linear regression analysis using the ordinary least square method. The findings were presented in tables and figures. The study’s findings established significant, negative and good linear relationships between banks’ NPLs and interest rate; interest rate spread and total assets. Significant, positive and good linear relationships between banks’ NPLs and cost income ratio; and, capital adequacy were also adduced. The study concludes that there is a strong relationship between financial performance of commercial banks with interest rate. The study recommended that there is need for banks to apply efficient and effective credit risk management that will ensure that loans are matched with ability to repay and minimize on their interest rate spread and other incidental costs so as to reduce loan default