The banking system is considered a key component in provision of funds for economic development through financing capital accumulation, technological innovations, productivity growth and enhancing other sustainable economic growth rates and consumption. Pricing of funds through lending rates and efficient banking systems are essential for acceleration of economic growth. This would spur economic growth and enhance the financial sector development. Lending rates in Kenya have been high for a long time and various efforts have been made to arrest the situation over time notably: Introduction of the KBRR by the CBK, attempts to cap lending rates in 2010 by the Kenya National Assembly and finally the enactment of the banking amendment Act of 2016. However, the lending rates still remain high despite capping. Research done on effect of various variables on lending rates has assumed direct relationship and has produced mixed results. This study sought to investigate the effect of bank characteristics and macroeconomic variables on lending rates among commercial banks in Kenya. Specifically the study sought to: establish the effect of bank size, credit risk, and liquidity risk, operating costs, Gross Domestic Product growth rate and inflation rate on lending rates among commercial banks in Kenya. The study further sought to establish the moderating effect of political risk on the relationship between bank characteristics and lending rates among commercial banks in Kenya and to determine the moderation effect of political risk on the relationship between macroeconomic variables and lending rates among commercial banks in Kenya. The research philosophy for this research was positivism. Explanatory non-experimental research design was employed. The target population was thirty nine (39) commercial banks from whom secondary data was collected by way of census since these are the banks from which complete information could be obtained for meaningful analysis for the study period 2006-2015. Descriptive Statistics including Mean and Standard deviation and inferential statistics: Panel regression analysis and Correlation analysis were carried out. Data analysis was run on the Stata 13 package and findings presented in figures, tables, graphs and charts while deriving conclusions and recommendations from the findings of the study. The study found that operating costs, credit risk and inflation had positive effects and were significant determinants of lending rates. However the effect of GDP growth rate and bank size was found to be negative and significant. Political risk was found to have insignificant moderating effect on the relationship between bank characteristics, macroeconomic variables and lending rates among commercial banks in Kenya. Based on the findings, the study concluded that bank size, credit risk, operating costs, GDP and inflation play a significant role in determining the lending rates of commercial banks. The study recommends that government pays attention to macroeconomic variables while controlling the domestic lending rates. The study further recommends that policy initiatives that will help to keep the lending rates at a low level take into consideration the need to enhance economic growth and reduce inflation. The study recommends in conclusion that commercial banks that wish to adjust their lending rates focus on their internal factors such as bank size, credit risk and their operational cost and that the government considers deregulation on lending.
CHAPTER ONE INTRODUCTION
Background to the Study
The financial institutions and the banking system are among the key pillars of an economy especially while considering their key role in reallocation of funds from agents with more to those with deficit. Banks also help in solving the problem of information asymmetry and diversify risks hence leading to reduction in the cost of financing and allocation of funds within the economy. Therefore the banking system is considered a key component in provision of funds for economic development through financing capital accumulation, technological innovations, productivity growth and enhancing other sustainable economic growth rates and consumption.
According to Crowley (2007), pricing of funds through lending rates and efficient banking systems are essential for acceleration of economic growth. This would spur economic growth and enhance the financial sector development (Bekaert et al., 2005; Ang & McKibbin, 2007). However, many nations in the Sub Saharan Africa (SSA) still struggle with skyrocketing lending rates (Maina, 2015). The lending rate environment and stability is a key component for economic growth and in the performance of the returns on investments (Levy et al., 2008). This could explain the growth in non-performing loans due to increasing gross loans probably an indicator of reduced returns on investments leading to reduced ability to repay the same loans taken with the hope of increasing returns from the financed businesses (Table 1.1). Financial liberalization that came into being in the 1990s was expected to ensure a healthy, competitive and efficient financial sector hence reducing lending rates (Folawewol & Tennant, 2008).
Lending rate is the price borrowers pay to acquire and use money from lenders or financial intermediary such as commercial banks (Maina, 2015). The Institutions can be either BFIs or NBFIs. With a slight deviation is Kithinji and Waweru (2007) who indicate that the lending rates can be thought of as “Rent for money”. Lending rates reflect market information on the volatility of the power of money and likelihood of change in future inflation (Ngugi, 2001). This is based on the analogy that, lower lending rates imply accessibility of funds by borrowers some of whom might just be lovers of money which might fuel inflation or in the converse high lending rates would imply inaccessibility of funds hence reversing inflation (Were & Wambua, 2014).
High lending rates depict inefficiency in the banking sector. Statistics show that Kenya has higher lending rates than many African Nations (See table 1.1) and this would imply that the banking sector in Kenya is inefficient (Hassan & Khan, 2010). Bank lending rates in Kenya have received considerable attention in the popular press (Hafer, 2010). There is a widespread opinion that the rates charged by commercial banks exceed their cost of funds by an abnormal amount.