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

Abstract

Commercial banks are identified as key in driving economic growth and development as they improve financial inclusion in both less developed and developed countries. In Kenya, banks have previously enjoyed high returns by charging interest rates as determined by the market forces of demand and supply which the government perceived as a high cost at the expense of borrowers. This resulted to the Kenyan government introducing interest rate cap in September 2016. The interest rate were capped at 4% above the central bank rate. The enactment and implementation was to lower the cost of credit to the Kenyan populace. The objective of this study is to investigate the impact of interest rate capping law introduced in the country. It has been two years since the enactment of the law though data for most commercial banks are complete for one year after capping of interest rates. This period may not be long enough to display the long term effect, so to achieve results for the study, different variables that were represented by ratios measuring financial performance were considered 3 years before capping and 1 year after capping in order to understand impact of implementation of the law on financial performance of commercial banks. Using the central bank supervision data covering the period before and after interest rate cap together with financial statements of the commercial banks, our analysis indicated that the interest cap is having significant impact on the Liquidity ratio and Lending rate of the commercial banks. Further to this interest rate cap is a hindrance on the interest rates determination by the forces of market demand and supply.