The Effect Of Interest Rate Capping On Profitability Of Tier One Commercial Banks, In Kenya

Abstract

The step taken in capping interest rates and setting a floor on deposit rates has a very noble objective, but in practice it has ended up with very adverse consequences. Some other countries have tried this before and evidence shows that in such countries the ratio of credit to GDP is lower than the regional average. The purpose of the study was to address the effect of interest rate capping on profitability of tier one commercial banks, in Kenya, a case of selected commercial banks in Nairobi.. The specific objectives were to address the effect of asset shifting, credit access and nonperforming loans on profitability of tier one commercial banks in Kenya. The research design was descriptive design. The target population was staff in the selected banks. The sampling design was stratified random sampling design. During data collection, questionnaires were the main data collection method. After data collection, the data was analyzed by adopting quantitative technique. Presentation was done inform of diagram such as tables, pie charts and bar graphs. The study found that in asset shifting, presence of interest cap may discourage supply of funds to the financial system considering of fixed returns. This was found to limit the banks from realizing high revenues ultimately affecting profitability. Based on the credit access, the interest cap increases the problem of adverse selection as it restricts lenders‟ ability to price discriminate, as a result, interest caps prompts the banks to charge interest on flat rate regardless of good borrowers or bad borrowers. The study recommends that bank administrators should consider identifying alternative sources of revenues when striving to attain profitability considering that the presence of interest cap may discourage supply of funds to the financial system because of fixed returns.