Effect of Interest Rate on Lending Levels by Commercial Banks in Kenya

Abstract

The question of whether shifts in interest rates affect the lending levels have been widely examined in both academic and policy circles. Interest income on loans and advances still remain to be a major source of revenue to the banks income portfolio followed by investments in government securities. The loanable fund theory presupposes that the level of interest rates influence the demand and supply of loans hence equilibrium interest rate determines the amount of loanable funds commercial banks will advance. On the other hand, other researchers hold that there are other mechanisms that play an important role in influencing bank’s lending activities despite change of policy on interest rate. This study sought to determine the effect of interest rates on lending levels by commercial banks in Kenya. The independent variable was interest rate as measured by quarterly CBK lending rate. The control variables are economic growth as measured by quarterly GDP growth rate and inflation rates as measured by quarterly CPI. Lending levels by commercial banks in Kenya were the dependent variable which the study sought to explain and they were measured by quarterly average loan book value in natural logarithm form. Secondary data was collected for a period of 10 years (January 2008 to December 2017) on a quarterly basis. The study employed a descriptive research design and a multiple linear regression model was used to analyze the relationship between the variables. Statistical package for social sciences version 21 was used for data analysis purposes. The results of the study produced R-square value of 0.848 which means that about 84.8 percent of the variation in lending levels by commercial banks in Kenya can be explained by the four selected independent variables while 15.2 percent in the variation was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with lending levels by commercial banks in Kenya (R=0.921). ANOVA results show that the F statistic was significant at 5% level with an F statistic of 67.049. Therefore the model was fit to explain lending levels by commercial banks in Kenya. The results further revealed that individually economic growth is not a significant determiner of lending levels by commercial banks in Kenya while interest rate and inflation rate are significant determiners of lending levels by commercial banks in Kenya. This study recommends that there is need for policy makers to regulate interest rate levels prevailing in the country bearing in mind that they significantly influence lending levels by commercial banks in Kenya.