Effect of selected macroeconomic variables on non-performing loans in Kenyan commercial banks

Abstract

Non-performing loans can be defined as credit facilities, which for a long time do not generate returns. The role played by non-performing loans in triggering banking and financial crises in both most developed and least developed countries widely acknowledged. The aim of the study was to examine the effect of selected macro-economic variables on non-performing loans in Kenyan commercial banks. The study used time series data to model the relationship between non-performing loans and selected number of macro-economic variables.The use of time series analysis was deemed advantageous due to the dynamic nature of time series model. The time series were found to be non-stationary but stationarity was attained after taking the first difference. Further, cointegration test indicated that the study variables were not cointegrated. The study used vector autoregression (VAR) models. Vector error correction (VEC) models were found inappropriate as the study variables’ were not cointegrated. The study found out that there was no long run relation between inflation rate, interest rate, foreign exchange rate and non-performing loans. Further, the one month lagged effects on inflation rate, non-performing loans and three months lagged effects on non-performing loans were found to be significant in determining the non-performing loans. The Granger causality test indicated that only inflation rate Granger causes non-performing loans.In conclusion, in long run interest rate, inflation and foreign exchange rate did not influence non-performing loans while in the short run only inflation rate influenced non-performing loans.