Effect of Inflation on the Loans Default Rate of Commercial Banks in Kenya.

Abstract

The study aimed at identifying the effect of inflation on loan default rate. Other independent variables that comprised of macroeconomic variables were identified by the study and their effects on loan default rate were also investigated. The data collected involved quarterly data for each variable for a period of twenty years, and an ordinary least squares (OLS) method was identified as the tool of analysis. Data analysis that was undertaken first involved describing main characteristics of each variable as it expressed the variable’s mean and standard deviation. Diagnostic tests were also undertaken in the study to ensure that conditions required for use of OLS were complied with. However, the variables failed on a number of tests that necessitated the data to be treated through standardization. The study also preferred the use of non-parametric tests instead of use of parametric tests. The correlation analysis undertaken by the study found that both inflation and economic growth had significant and negative correlation on loan default rate, which indicated that an increase in inflation as well as an increase in economic growth would lead to a decrease in loan default rate as inflation would make loans relatively cheap while economic growth would ensure that borrowers are able to make good income and therefore oblige to their financial obligations. Exchange rate fluctuations and lending interest rates had positive correlation though exchange rate fluctuations had almost zero correlation against loan default rate. The regression analysis that was undertaken by the study indicated that the model adopted by the study was only able to describe 18.6% of the changes in loan default rate. Other changes in loan default rate were therefore explained by other factors that were not in the model. The p value of the F test undertaken was less than 0.05 that led the null hypothesis to be rejected and the study concluded that there was significant effect of inflation on loan default rate for banking sector in Kenya. Therefore, the study recommends7 that7 the7 government7 should7 implement7 policies7 that7 will keep inflation under control. The study would also advise the government to implement policies that are likely to boost and improve economic growth. The study also suggests that the government refrain from encouraging increased exchange rate fluctuations.