Interest rate regulation and bank lending behaviour: evidence from Kenya

Purpose - This study aims to determine the impact of interest rate regulation on bank lending behaviour. The application of interest rate caps as a financial repression and regulatory measure has sparked debate for decades. This study contributes to the ongoing debate on the consequences of rate caps on banks’ lending behaviour in Kenya. Design/methodology/approach - This study uses both fixed effects and two-step generalised method of moments techniques to establish the effects of interest rate caps on credit allocation across three sectors of the economy: government, private and interbank lending. To achieve this, the authors used data drawn from 35 licenced commercial banks in Kenya from 2004 to 2021. Findings - The results, which are robust to endogeneity and other diagnostic checks, reveal shifts in lending behaviour by banks towards the government, and less to the private sector and interbank lending in rate cap periods. This study finds that rate caps have a significant and positive impact on bank lending to the government. This significant positive impact appears subdued for private and interbank lending. Research limitations/implications - From a policy perspective, the findings highlight that interest rate caps do not benefit the private sector. An important implication of this study is that such policies may have unintended consequences of hindering growth in a broader economy. This study has the potential to inform policymakers and the banking industry in East Africa about the effects of interest rate regulation. High lending interest rates have seen some countries, such as Kenya, imposing interest rate caps and subsequently repealing them. Other countries, such as Uganda, were in the process of considering rate caps but have deferred the decision. Originality/value - This study contributes to the ongoing debate regarding the implications of interest rate controls in developing economies. The study uses robust estimation approaches to argue its case for a separate examination of rate controls in a single-country setting owing to the unique institutional and contextual realities inherent in every jurisdiction.