The Relationship Between Macroeconomic Factors and the Level of Nonperforming Loans in the Banking Industry in Kenya

Abstract

Considering that the banking industry is the backbone of the Kenyan economy, and that it is a critical vehicle that links the Kenyan economy to the rest of the world, it is important to understand the relationship between macroeconomic factors and the level of nonperforming loans in the banking industry in Kenya. High levels of nonperforming loans can lead to a banking crisis hence the need to understand how this level of nonperforming loans may be affected by macroeconomic factors such as lending interest rate, interest rate spread, inflation rate and real GDP growth rate. The objective of this study was to find out the relationship between macroeconomic factors and the level of nonperforming loans in the banking industry in Kenya. A quantitative research design was adopted in the study. The population consisted of forty three commercial banks and one mortgage institution licensed to operate in Kenya as listed by the Central Bank of Kenya. Secondary data for the banking sector as a whole was collected for gross loans, gross nonperforming loans, average lending interest rate and average interest rate spread for a ten year period from 2003 to 2012. Annual data on average inflation rate and real gross domestic product growth rate for the ten year period was also collected. Statistical analysis was then done using SPSS analytical software. The research findings established that there was a positive relationship between the dependent variable (level of nonperforming loans) and interest rate spread and lending rate as the independent variables with a correlation of 0.65 and 0.501 respectively. The findings also established that there was no relationship between the dependent variable (level of nonperforming loans) and inflation rate and GDP growth rate as the independent variables whose correlation was 0.050 and (0.028) respectively. The researcher also found that the model and individual variables were not significant implying there may be no relationship between the level of nonperforming loans and interest rate spread, lending rate, inflation rate and GDP growth rate. The researcher recommended that the management of commercial banks should be careful when increasing the lending rate and the interest rate spread since the researcher found it to have the greatest impact on the level of nonperforming loans.