Effect of Collateral on Loan Repayments Among Kenyan Commercial Banks

Abstract

Collateral has been extensively utilized as a means to minimize the asymmetric knowledge that exists between borrowers and lenders. This reduces the risk of credit restriction. The overall objective of the study was to to establish the effect of collateral on the default rate among commercial banks in Kenya. The target population was all the 42 licensed banks. The study employed a census and it examined the whole population. However, 3 banks were expunged from the analysis because they became licenced before the study period or ceased operations in the study period. Thus, 39 commercial banks were utilized for the analysis. Secondary sources of data were employed. Data was collected for the period from 2016 to 2020; the period comprised of five years. The study applied correlation analysis and multiple linear regression model with the technique of estimation being Ordinary Least Squares (OLS) so as to establish the relationship of collateral, the lending rate, and bank size. The two analysis methodologies were utilized in the current study. The study findings were that in the time period sampled from the year 2016 to 2020, only bank size was significantly related to default rate. They had a significant positive correlation. However, in the time period sampled from the year 2011 to 2015, the study findings revealed that collateral, lending rate, and firm size were not significantly correlated to default rate. Additional findings from the two sampled time periods were that the model entailing; collateral, lending rate, and bank size explains to a least extent default rate by having a co-efficient of determination of 5.22% and 2.07% respectively. Thus, 5.22% and 2.07% of the variations in default rate were explained by the model entailing collateral, lending rate, and firm size in the periods ranging from 2016 to 2020 and 2011 to 2015 respectively. Further findings” were that the model entailing; collateral, lending rate, and bank size does not significantly predict the default rate. The final findings were that collateral, lending rate, and bank size did not individually have a significant relationship with default rate. Policy recommendations were that the policy makers should not majorly focus on collateral when trying to mitigate the default rate of financial institutions. Further recommendations to the financial institution regulators is to institute policies to increase the banks total assets, for instance, by increasing the core capital requirement, in order to mitigate the default risk. They may try to promote mergers, acquisitions, and amalgamations of financial institutions. Recommendations are generated to the financial sector practitioners and consultants are for them not to focus on collateral when crafting strategies to mitigate the default rate in their respective financial institutions. The final recommendations to the financial sector practitioners and consultants are to focus on bank size when crafting strategies mitigate the default rate. They may opt for mergers, acquisitions, and amalgamations of their respective financial institutions.