CAPPING OF COMMERCIAL BANK INTEREST RATES AND ITS IMPACT ON NUMBER OF LOAN ADVANCES GENERATED BY MICRO FINANCE INSTITUTIONS (original) (raw)

The purpose of this study was to examine if the number of loan advancements by micro finance institutions was affected after interest rate caps on commercial bank loans. From previous research, interest rate caps have been known to lead to disinter-mediation and reversing the gains made of financial inclusion, this study sought to investigate if this is the case in Kenya, whether loan borrowers perceived to be of high risk were locked out from accessing loans from commercial banks and if they turned to an alternative financier such as micro finance institutions. Three research questions emerged to provide a deeper insight into the study: Factors Considered while Determining Interest Rates (ii) Evaluation of Micro finance Institutions (MFIs) Sources of Finance and (iii) Evaluation of how Interest Rate Caps affect financial institutions. The research methodology used was Causal Explanatory as the study was concerned with understanding the relationship among variables. The population consisted of 108 outlets of financial institutions, included were: One representative of the Umbrella body of cooperative societies (KUSCCO) and 107 outlets of the 13 regulated MFIs. Using Yamane 1967 formula, a sample of 86 was arrived at. The researcher administered 86 questionnaires but only 67 responses out of the 86 were received, this is a response rate of 78% which is considered appropriate for the study. Secondary data was also collected from the databases of World Bank and Central Bank of Kenya. Stratified sampling technique was used to identify and collect data from representatives, SPSS (Statistical Package for Social Sciences) was used to code and analyse the data. Regression analysis was used to determine the relationships between variables and descriptive statistics using frequency distribution, percentages and mean was carried out. Pie charts and graphs were also used to display detailed information. Lastly, interpretation of results was done to give meaning to statistical results obtained from regression analysis and descriptive statistics. It was established that there are a number of factors considered while determining interest rates. For analysis purpose, researchers divide the factors considered into three main categories namely: Bank Specific Factors, Industry Related Factors and Macro Economic Factors. Bank Specific Factors includes: Risk aversion, bank specialization and off balance sheet exposure. Industry Related Factors include: Competition and market forces. Macro-Economic Factors include: Monetary policy and business cycle. vi It was also established that micro finance institutions depend on different sources of finance, among the sources of finance mentioned are: Client deposits, donor funding, retained earnings and share holder funds. Donor funding was the traditional form of finance for most MFIs as they were first established as Non-Governmental Institutions but over the years, this source of finance has proven to be unreliable especially if sustainability of MFIs is to be considered. Interest rate caps have both positive and negative effects. Interest rate caps could be used to promote operational efficiency as financial institutions operating at inefficient levels are coerced to reduce on costs, interest rate caps can also be used for consumer protection from dominant players in the financial markets. On the negative, they may cause disinter-mediation when financial institutions lock out part of the market segment consisting of borrowers considered being high risk. Interest rate caps also affect Central Bank’s ability to make monetary policy decisions. It was concluded that MFIs consider many different factors before interest rate determination takes place, risk featured as a prominent factor. It was indicated that client deposits was the cheapest source of funding. After interest rate caps came into effect, loan requests at commercial banks increased but this did not translate to loan disbursements as commercial banks opted to lend more to less risky client category made of corporate clients and government therefore locking out low income earners, small and medium enterprises and new borrowers. It was also revealed that micro finance institutions did not increase loan disbursements as was expected as locked out borrowers turn to MFIs for financing. As risk featured as a major interest rate determinant, the study recommended that financial institutions should make more use of Credit Reference Bureaus for credit rating purposes as low income earners and SMEs could have a good credit stand despite lack of collateral. Also that, MFIs should be encouraged to make more use of technology to lower high administrative costs as is the case with Mshwari which lends out micro loans. The study also recommended that interest rate caps should be slightly increased to allow for inclusion of high risks clients but should not been done away with for consumer protection from dominant players in the financial markets.