Abstract:
Interest rate earnings is one of the critical components in lending decision process of
commercial banks. Capping on interest rates have been declining over the past several
decades as most developed states and more of upcoming states continue relaxing their
fiscal policies. The general objective of this study was to analyse effect of interest rate
capping on interest earnings among commercial banks in Kenya. The specific
objectives were to analyse the influence of: credit risk, capital adequacy, operation
efficiency, and liquidity risk and bank size on interest rate earnings. The study
adopted explanatory 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 in normal operation
as at 31st December 2018 were used giving 228 firm observations. Interest rate
earnings was informed by Dealership Model. Dynamic Stochastic General
Equilibrium modelling-Generalized Method of Moments approach was used in
analysis. Results for the period before interest rate capping in Kenya indicated that
before interest rate capping in Kenya, coefficients of lagged interest rate and capital
adequacy p 0.000 0.05 and p 0.000 0.05 respectively, were positive and
statistically significant at 5% level of significance. This implied that increasing one
unit of previous year’s interest rate earnings and capital adequacy had a positive effect
of 0.7998 and 0.0197 units respectively. Coefficients of operation efficiency and
liquidity risk were negative and significant, p 0.036 0.05 and
p 0.000 0.05 respectively, at 5% level. This implied that as operation efficiency
and liquidity risk increased by one unit, interest rate earnings reduced by 0.0165 units
and 0.0375 units respectively. Higher amounts of operating expenses could be
associated with higher volume of banking activities and therefore higher revenues
necessitating the commercial bank in Kenya to reduce interest rate earnings.
Coefficient of liquidity risk indicated that as one unit of liquidity risk increased,
interest rate earnings reduced by 0.0375 units which implied that interest rate earnings
for commercial banks in Kenya which were highly liquid were associated with lower
interest rate earnings. Coefficient of bank size p 0.087 0.1was negative and
significant at 10% level of significance. For every unit increase in bank size, interest
rate earnings reduced by 0.1576 units. Results for the period after interest rate capping
was relaxed showed that coefficient of lagged interest rate
was p 0.009 0.05which implied that increasing one unit of previous year’s
interest rate earnings had a positive effect of 0.4246 units implying that one unit of the
previous interest rate increased interest rate earnings by 0.426 units. Coefficient of
capital adequacy was 0.0479 which was positive and significant at 10% level of
significance which implied that for every unit coefficient of capital adequacy, interest
rate earnings increased by 0.0479 units. Coefficient of bank size was 0.0304 which
was negative and significant at 10% level which implied that for every coefficient of
bank size, interest rate earnings increased by 0.0479 units. Government could
consider relaxing now and in future interest rate capping in order to avoid effect of
capital adequacy, operation efficiency, liquidity risk and bank size on interest rate
earnings. Commercial banks could improve their operation efficient so that the cost of
funds can be reduced leading to improvement of commercial bank performance.
Commercial banks be encouraged to expand their market sizes in order to increase
collection of deposits and consequently performance.