Effect of Interest Rate Capping on Financial Performance of Listed Commercial Banks in Kenya

Abstract

This study was focused in determining the impact of interest rates caps had on financial performance of listed commercial banks in Kenya. The key measure adopted was the return on investment of the listed banks, and was complemented by incorporation of amounts of customer deposits and also the non-performing loans to have a wider look at the potential effects of the capping on the banking industry. The study used Stata software and also an excel software for the analysis and focused on 12 quarters before capping and 12 quarters after the interest rate capping. Nominal amounts of ROI were used while for both customer deposits and non-performing loans, their growth was used. An event study methodology was used and the main analysis was based on a paired t-test of the two periods. Descriptive statistics and trend graphs were also used. The average ROI was found to decrease from 1.9% to 1.6% while its standard deviation increased from 0.0074 to 0.0079. This implied that the capping affected financial performance negatively by reducing profitability and also increasing volatility in returns. Customer deposits were also found to decrease in the rate at which they used to grow, from 4.06% to 1.53%. The volatility however decreased from 0.028 to 0.023 meaning that the growth in deposits became more predictable and stable. The growth in non-performing loans was also noted to decrease in the rate at which they used to grow, from 10.12% to 5.56%. Like customer deposits, volatility in change in non-performing loans became more stable with a decrease in its standard deviation from 0.145 to 0.047. Plotting the graphs, it was noted that ROI had been reducing long before the capping, while the nominal amounts of customer deposits and non-performing loans were growing. There was no observed changes in the direction of the growth, only the rates of change were observed. Using t-test, it was noted that none of the changes were significant as measured by the p-values at a 95% confidence interval. The study findings concur with perceptions, and support the idea of free market theory where government should not control the operations of an economy, and market forces of demand and supply should be left to play and determine equilibrium prices, including for money (interest rates). The researcher therefore notes that the removal of interest rate capping was a good idea. The findings of this study imply that, ROI for listed banks can be enhanced by letting banks price their loans as per the demand and supply for funds, and also taking measures that increase customer deposits. Considering the significance levels, it can also be noted that there many other factors that can influence ROI for commercial banks and thus further research is needed. The research would help in identifying these other factors and thus enhance knowledge on financial performance of listed banks. Future research is also required to establish why post-capping change in non-performing loans were positively correlated with ROI, while it is expected that it should influence ROI negatively as banks lose on interest. There are possibilities that performance of listed commercial banks was totally disrupted the capping.