Credit risk and private sector loan growth under interest rate controls in Kenya

Abstract

The study examined the effect of credit risk on loan growth in the banking system in Kenya using panel data constituting 40 commercial banks over the period 2009 to 2018. The study employed a dynamic panel data approach to analyze both aggregated banking sector and bank-tier level models before and during interest rate controls regimes. Findings of the study show that credit risk affects loan growth for all banks on aggregate, but these effects are heterogeneous across bank tiers. In particular, the effect of credit risk on loan growth is found to be stronger for large and small banks than for medium size banks, both in the period before and during interest rate controls. The results also show that other bank specific factors, mainly size and capitalization are important for loan growth while macroeconomic factors are not significant in explaining loan growth for all banks. In addition to credit risk, liquidity, deposit growth, inflation and economic growth are the most important factors determining loan growth for small banks in the period of interest rate controls. Whereas the impact of monetary policy rate changes on loan growth has the same effect across all bank tiers in the period before interest rate controls, it is heterogeneous across the bank tiers in the interest rate control period.