The Effect of Central Bank Rate on Financial Performance of Commercial Banks in Kenya
Abstract
Interest rates are fundamental to profitability of any business organization and are normally expressed as a percentage rate over the period of one year. Interest rates as a price of money reflect market information regarding expected change in the purchasing power of money or future inflation. The objective of the study was to investigate the relationship that exists between the Central Bank Rate and the financial performance of the commercial banks in Kenya. This study was anchored on the classical theory of interest rates, the Keynesian Theory, The Rationale Expectation Theory of Interest Rates and Loanable fund theory. This study was descriptive in nature. The target population of the study comprised of all the 43 licensed commercial banks in Kenya as at 31st Dec 2014. The study used secondary data. Regression analysis revealed that there was a strong correlation between the quarterly return on assets of Kenyan commercial banks, the quarterly average central bank rate, the quarterly average liquidity risk and the quarterly average inflation rate. The study recommends that the monetary policy committee of the Central Bank of Kenya should sets the rate with a good level of effectiveness. The study also recommends that the committee should therefore enhance the initiatives that are employed in order to set a good rate. Some of the limitations were that the study used a limited period of 10 years, which yielded only 40 observations (Quarters). There could have been more insight where the study period could be extended for a longer period of more than 10 years. The data used was also largely aggregated, for the entire banking industry in Kenya. Considering the fact that the Central Bank Rate applies to all licensed commercial banks, the use of aggregated data became an ideal choice. It could however not allow for an examination of how individual commercial banks attempt coping with the changes that are normally occasioned by changes in the Central Bank Rate.
Keywords: Interest rates, Financial Performance and Commercial Banks
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