ABSTRACT
Commercial banks are very important in an economy as they mobilize savings for productive investments and facilitating capital flows to various sectors in the economy, thus, stimulating investments and increase productivity. Their operations are guided by monetary policy actions under central bank directives. Currently banks charge 18 per cent, as per Central Bank of Kenya data, with some borrowers paying as high as 24 per cent for short- to medium-term loans contrary to the policy actions. Pleading with banks to lend at lower rates in the recent past has, however, not borne fruit, leaving the lenders to charge borrowers high and arbitrary rates that have only invited legislative action from Parliament to Capping interest rates. This study sought to determine the effects of selected monetary policies on loans portfolio performance among commercial banks in Kenya. The study specifically determine the effects of open market operations, central bank rate, minimum reserve requirements and Kenya bankers’ reference rate on loans portfolio performance among commercial banks in Kenya. The findings of the study will be important to policy makers, commercial banks and scholars. The study targeted 30 commercial banks and used 30 credit officers, one from each bank to collect data. This study adopted a descriptive survey design and employed census in the selection of respondents. The study used questionnaires to gather primary data from the respondents and secondary data sheet to collect secondary data. Reliability test of the instruments was done using Cronbach alpha coefficient. The statistical package for social sciences (SPSS) version 20 was used to generate both descriptive and inferential statistics. Analysis of data was done using descriptive statistics specifically mean, standard deviation, percentages and frequencies. The processed data was presented using tables. Phi and Cramer’s V was then performed to establish the strength of relationship between the independent variables and the dependent variable and Chi-square was used to test for the significance of each predictor variables in the model at 0.05 (significance level) and also multiple regression was also done in order to establish the nature of the relationship between open market operations, central bank rate, minimum reserve requirements and Kenya bankers’ reference rate. The findings of the study showed that there was no significant relationship between open market operations, central bank rate, Kenya bankers’ reference rate and loans portfolio performance. The study recommended that central banks should re-evaluate the policies governing open market operations especially outright transactions and reserve transactions, that central bank should continue to improve their monitory policies and should continue to train staff to the highest expertise. The study also recommended that central bank rate and minimum reserve should be reduced and much with the prevailing inflation rate. It is necessary that further study be done on the effect of open market operations on loans portfolio performance among commercial banks.
CHAPTER ONE
INTRODUCTION
Background of the Study
Monetary policy encompasses any policy designed to influence the level of economic activity by influencing the supply and demand or the cost of money. Monetary policy ensures stability of prices, interest rates and exchange rates. This protects the purchasing power of the Kenyan shilling and promotes saving, investment and economic growth. Through monetary policy, the economy creates conditions that allow for increased output of goods and services in the economy, thereby improving the living standards of the people. Achieving and maintaining a low and stable lending rate together with adequate liquidity in the market leads to; improved economic growth, higher real incomes and increased employment opportunities (Janet, 2012). Monetary policy is therefore; designed to support the government’s desired economic activity and growth as well as employment creation. The monetary authority uses monetary instruments to conduct monetary policy operations in a monetary targeting framework that are deemed to have implications for bank loans portfolio performance. These monetary policy tools of operation include;
First, the Open market operations which are the primary monetary policy instruments for promoting economic growth and other policy goals and is used by CBK through purchases and sales of eligible government securities to regulate the money supply and the credit conditions in the economy. Open market operations can also be used to stabilise short-term interest rates. The buying and selling of government securities influences the interest rates and the supply of money and credit. In conducting open market operations the central bank uses a number of different techniques ranging from outright transactions and reverse transactions (CBK, 2014). Outright operations are normally associated with the management of an “outright asset portfolio”, which often mirrors the long-term trend increase in the issuance of currency in circulation. When the Central Bank buys securities on the open market, it increases the reserves of commercial banks, making it possible for them to expand their loans which increase the money supply (Weller, 2009).
Secondly, the central bank rate which is the basis for the central bank of Kenya to provide secured loans to commercial banks on an overnight basis. The rules governing the operation of the CBK discount window are reviewed from time to time by the Bank. Currently, banks utilising the CBK Overnight Window are charged the CBR plus a high penalty. Moreover, banks making use of this facility more than twice in a week are scrutinised to establish whether prompt corrective action is required to address any weakness that is not merely temporary (CBK, 2014). Central bank interest rate cuts, is aimed at establishing an appropriate atmosphere to reinforce growth in the national economy by reducing credit costs. When the central bank raises interest rates, banks react by increasing their lending rates, making borrowing harder thus affecting mortgage rates, car loans, business loans and other consumer loans.
Thirdly, the minimum reserve requirement which the central bank uses in controlling the money supply (Contessi, 2013). In Kenya, banks are required to hold an amount of funds in reserve against special deposit liabilities in the form of vault cash or deposits with the central Bank. Every bank needs to maintain a certain balance in its reserve account to meet requirements arising out of; the need to maintain CRR, to invest in government securities, for settlement of inter-bank obligations and for precautionary reasons (Chowdhury, 2012). The ratio is currently 5.25 percent of the total of bank’s domestic and foreign currency deposit liabilities. A reduction in the CRR releases reserves thus enhancing the capacity of commercial banks to expand credit.
Finally, the Kenya bankers’ reference rate which is taken into account when dealing with variables like investment, consumption and unemployment. A higher percentage of revenues generated by banks come from interest income on lending. The central banks generally tend to reduce this bench mark rate when it wishes to increase investment and consumption in the country's economy. However, a low interest rate as a macro- economic policy can be risky and may lead to the creation of an economic bubble, in which large amounts of investments are poured into the real-estate market and stock market.
Interest-rate adjustments are thus made to keep economic variables within a target range for the health of economic activities or cap the interest rate concurrently with economic growth to safeguard economic momentum (Ngumo, 2012).
These monetary policy tools are viewed by the industry players and the general public to have less influence on the transmission mechanisms to control the operations of the banking sector since it was liberalized in the last decade. It is estimated that 80 percent of Kenyans are locked out of borrowing as a result of rising interest rates on loans. The high cost of borrowing lead to legislative action that resulted to the introduction of the Donde bill of 2000. The bill sought to have the government rein in interest rates that banks could charge their customers. The bill argue that at 24 percent, the interest rates charged by the banks had made borrowing out of reach of many Kenyans and businesses were failing after banks moved in to auction them for failure to service loans due to the high interest rates. Industry players in the country welcomed the bill, saying that it would form part of recovery efforts the country needed to kick start the economy (CBK, 2000).
Monetary policy in Kenya
Kenya’s monetary system has undergone reforms since the establishment of central bank of Kenya in 1966 aimed at achieving; stability so as to ensure that banks’ and other financial institutions taking deposits can safely handle the public’s savings and ensure that the chances of a financial crisis are kept to a minimum; efficiency in the delivery of credit and other financial services to ensure that the costs of services become increasingly affordable and that the range and quality of services better cater to the needs of investing businesses; and improved access to the financial services and products for a much larger number of Kenyan household (Mwega, 2014). Commercial banks in Kenya cater for the above needs by developing an array of new financial instruments and techniques to adopt the ever changing environment influenced by monetary policy (Njanike, 2009). These products include loans portfolio which varies from one banking institution to another as they offer wide ranges of financial services. These loans are the principal economic functions of commercial banks in Kenya and account for half or more of their total assets and about half to two thirds of their revenues (Hudgins, 2005). Bank Loans are greatly
affected by monetary actions, which tend to be concentrated in the loans portfolio, and can cause serious financial problems for banks.
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Item Type: Kenyan Topic | Size: 63 pages | Chapters: 1-5
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