The Relationship Between Loan Duration and Interest Rates for Commercial Banks in Kenya

Abstract

Commercial banks’ loans still remain the largest proportion of total financial sector assets even if a number of new financial institutions have arisen to provide increased competition to commercial banks. The analysis of changes in bank lending interest rates and loan duration is of great significance both in terms of monetary policy and financial stability. The study sought to establish the relationship between loan duration and lending interest rate in Commercial Banks in Kenya. This study was conducted through a case study research design. The study targeted commercial banks in Kenya. Time series secondary data on a monthly basis covering the period 2009 to 2013 was used in the estimations. The study adopted the regression model for data analysis. The study found that there exist a positive relationship between the lending interest rate and average loan duration. This implies that an increase in lending interest rate in months results to a decrease in average loan duration and vice versa. It found that increase in regulatory framework results to an increase in average loan duration. Effective regulatory framework enforces better liquidity and reserve ratios offered in the respective Commercial Banks thus leading to better and favorable average loan duration. The study found that an increase in lending risk results to an increase in commercial banks’ average loan duration. As a result of increase in lending risk, banks can control their exposure to risk by first limiting the quantity they lend and also monitor the actions of borrowers to protect their investment. Finally, the study found a positive relationship between interbank lending and average loan duration which shows that an increase in interbank lending results to an increase in average loan duration.