The effect of changes in interest rates on credit granted by commercial banks in Kenya

Abstract

Until June 1991, the Government of Kenya maintained a policy of interest rate control. This meant that the Government was instrumental in setting maximum nominal interest rates for lenders and borrowers; mandatory credit ceilings; compulsory reserve requirements on commercial banks and control over the allocation of credit thus repressing the economy. Since interest rates were liberalized in Kenya, no study has been undertaken to evaluate the effect of changes in interest rates on credit granted by commercial banks which is critical to spur economic growth, hence this study seeks to fill this gap. This study utilized time series secondary data to establish the effect of interest rates charged by commercial banks on credit granted by the banks. The data was obtained from the Central Bank of Kenya records and publications, and published accounts of commercial banks for the period 1992-2002 to test the following hypotheses: 1) Interest rates have no effect on credit granted by commercial banks in Kenya 2) Interest rates have an effect on credit granted by commercial banks in Kenya Regression analysis results indicate an inverse relationship between the level of interest rates and th~ amount of credit g:anted by commercial banks. When interest rates increase, the amount of credit granted by commercial banks to their customers decreases while when interest rates decline, the amount of credit granted by commercial banks increases. A t-test of the regression parameters particularly the slope (b) at 5% level of significance revealed that interest rates have no effect on the amount of credit granted by commercial banks in Kenya. This further confirms research findings of low correlation coefficients for all commercial banks implying the existence of a weak relationship between credit and interest rates. Research findings lead to the conclusion that interest rates are not the most important determinant of the amount of credit granted by commercial bank credit in Kenya.