Macro-economic Variables and Loan Default Rate: Evidence From the Banking Industry in Kenya

Abstract

In most of the global economies, one of the key sectors in boosting the economic growth is the banking industry. It facilitates the allocation of capital from surplus to deficit units. In essence, the sector determines the growth of countries‟ economies and future sustainability by offering varying services, such as permitting cross-border money transfers and assuring structured interaction between borrowers and savers. In a nation, enhancing client trust improves banking sector stability, which is important for long-term economic growth. However, the global banking sector has seen a rise in bad debts since 2007 when global financial crisis occurred, the global banking sector has seen a rise in bad debts, primarily as a result of Non-Performing Loans (NPLs) being treated as a balance sheet cost, resulting in a reduction in a bank‟s financial performance. The goal of this study is to determine the influence of macroeconomic variables on the default rate in the banking industry in Kenya. The research was influenced by the Arbitrage Pricing Theory (APT) and the Credit Portfolio View (CPV) model. The study used a descriptive research design. The population of the study was all the commercial banks licensed in Kenya of which a census study was undertaken. Quarterly and secondary data for the period 2011-2020 was collected from CBK website and analyzed by the study; the data collected was time series data. The current research utilized inferential statistics that entail multiple linear regression and correlation analyses. The results of the research showed that there is a positive significant correlation between the lending interest rate and default rate while there is a negative significant correlation economic growth and default rate as well as inflation rate and default rate. However, the study also established that fluctuation in exchange rates doesn‟t have a significant correlation with the default rate at the 5% significance level. The study also indicated that the coefficient of determination of the study was 18.6% and there was a significant effect of these macroeconomic variables on loan default rate for commercial banks in Kenya. Policy recommendations are made to the government officials and policy formulators in the financial sector, mainly the regulator, the CBK, and the Treasury, to majorly focus on the lending interest rate, economic growth, and inflation macro-economic variables when trying to mitigate the default rate of financial institutions. Further recommendations are generated towards financial institution‟s practitioners and consultants to monitor the lending interest rate, economic growth, and inflation macro-economic variables in order to regulate credit expansion in order to mitigate credit risk.