Influence of credit risk on interest rate margins in the midst of capping among commercial banks in Kenya

Abstract

Interest rate margin is one of the critical component in the lending decision process of commercial banks. Commercial banks are independent business entities that set their own interest rate margin based on the central bank base rates. The aim of this study was to analyze bank specific determinants influencing bank margins interest rates in the midst of capping among commercial banks in Kenya using secondary data for the period 2013 to 2018, a period characterized by unrestricted and restricted interest rate cap. The specific objectives was to analyze the influence of: credit risk, on interest rate margins. The study adopted exploratory research design. Panel data was employed using annual data over the period before interest rate, covering 2013-2015, and after capping of interest rate, covering 2016 to 2018. Thirty-eight commercial banks in Kenya which were in normal operation as at 31st December 2018 were used giving 228 firm observations. Interest rate margins was informed by Dealership Model and its extensions while analyzing the influence of bank specific determinants, that is, credit risk, capital adequacy, operation efficiency and liquidity risk on interest rate margins. Applying STATA 13.0 employing Dynamic Stochastic General Equilibrium modeling, Generalized Method of Moments approach was used in the analysis. Descriptive statistics in form of pie charts, graphs, and summary statistics were presented. Inferential statistics was analyzed using regression analysis to establish the influence of bank specific economic determinants on the interest rate margin. The findings would be useful to policy makers, shareholders, customers in the respective commercial banks in Kenya. The government could also utilize the findings in making policies affecting commercial banks in Kenya which could have an impact on interest rate margin.