Effects Of Inflation On Commercial Banks’ Lending
[A CASE OF KENYA COMMERCIAL BANK LIMITED]

In Kenya , the average lending rates have been reducing from a figure of 19 percent in  the year 2002 to an average of 13 Percent over the last five years .commercial bank‟s average lending rates declined from 13.74 percent in December 2006  to 12.56 per cent  in October 2007.there are a number of factors that have influenced the lending rates including inflation, government policies ,the macroeconomic variables and banks specific   factors such as return on investment   and covering cost of operation (Ndung‟u and Ngugi,2000).

The Central Bank of Kenya (CBK) has played an important role in formulating and implementing monetary policy directed at achieving and maintaining low inflation as one of  its     key  principal  objective  (Ndung‟u  and  Ngugi,  2000).Since  its  establishment  in 1966, the CBK has used monetary targeting framework to pursue the inflation objective. The monetary policy strategy has been and continues to be  based on the presumption  that money matters, that the behavior of monetary aggregates has major bearing on the performance of the economy  particularly inflation (Ndung‟u and Ngugi,2000).Although commercial banks lending rates are determined by numerous factors outside the CBK‟s control , the Monetary policy committee which is the key policy organ of the central bank notes that structural changes in the deposit and credits markets ,including introduction of development banking products , can play a significant role in influencing a downward trend in the commercial bank lending rates(Njuguna,1999).

Kenya commercial bank limited (KCB LTD) is the largest commercial bank in Kenya in terms of assets values. KCB dates back to 1896 when its predecessor, the National Bank of India opened an outlet in Mombasa. Eight years later in 1904, the Bank extended its operations to Nairobi, which had become the Headquarters of the expanding railway line to Uganda. The next major change in the Bank‟s history came in 1958. Grind lays Bank merged with the National Bank of India to form the National and Grind lays Bank. Upon independence the Government of Kenya acquired 60% shareholding in National & Grind lays Bank in an effort to bring banking closer to the majority of Kenyans (Kenya Commercial Bank [KCB], 2013).

In 1970, the Government acquired 100% of the shares to take full control of the largest commercial bank in Kenya. National and Grind lays Bank was renamed Kenya Commercial Bank. In 1972, Savings & Loan (K) Ltd was acquired to specialize in mortgage finance. In 1997, another subsidiary, Kenya Commercial Bank (Tanzania)

Limited was incorporated in Dar-es-Salaam, Tanzania to provide banking services and promote cross-border trading. Since then, the subsidiary has 11 branches. In  pursuit of  its Vision: To be the preferred financial solutions provider in Africa with a global reach, in May 2006 KCB extended its operations to Southern Sudan to provide conventional banking services. The subsidiary has 19 branches. The latest addition into the KCB Family came in November, 2007 with the opening of KCB Bank Uganda Limited which has 14 branches. In December 2008 KCB Rwanda began operations with one branch at Kigali. There are currently 9 branches spread out in the country (KCB, 2013).

The Government has over the years reduced its shareholding to 35% and more recently to 26.2% following the rights issue exercise in 2004, which raised Kenya shillings 2.45 billion in additional capital for the bank. In the second Rights Issue exercise held in the year 2008, the Government further reduced its shareholding to 23.1% after raising additional capital for Kenya shillings 5.5billion. The bank conducted the third Rights Issue exercise in 2010, in which the Government further reduced its shareholding to 17.74% after raising additional capital of Kenya shillings 12.5billion. In  2010 Savings and Loan (S&L) was merged with KCB providing access to mortgage finance through the bank's wide branch network of 222 branches (KCB, 2013).

Ralf et al. (2000) undertaking a study on the determinants of bank lending performance in Germany showed that lending rate is a key factor in the commercial bank lending policy such that when commercial bank lending volume decreases, the commercial banks‟ profitability on lending is depressed. He further observes that during economic boom in Spain over 1985-1997 period, the commercial banks increased their market share by increasing lending volumes even to borrowers of low credit quality thereby increasing the amount of bad loans. Brownbridge, (1998) asserts that poor quality loan faced by the local commercial banks in developing countries are compounded by variables that determine macroeconomic stability such as inflation rate and commercial bank lending rate which have consequences in loan quality from local commercial banks. The net effects of this action are the negative impact on the commercial banks‟ balance sheets. Quoting from assessment of the usefulness of total lending volumes by commercial banks as an indicator of commercial bank distress by Pesola (2001), Ezema (ibid) observes that increase in interest rates above expected one and the growth of commercial bank lending volumes may have contributed to banking crisis in Finland and Sweden.

According to Mangani (2009), both inflation rate and lending rate in Malawi between the years 1970 and 2008 exhibited an upward trend. The nature of behavior of these macroeconomic indicators may results into varying responses by the commercial bank borrowing and investment by both public sector and private sector. Latifet al. (2009) study on the analysis of determinants of investment in Senegal for the period spanning 1994 and 2000 reveals that the desire to invest comes out of low and favorable lending rates that induce high lending volumes by the commercial banks. Felicia et al. (2011) asserts that in Nigeria, commercial bank deposits have the greatest impact on their lending behavior while Usman (1999) asserts that major regulation affect commercial banks‟ lending in Nigeria is the restriction on the amount of interest they are allowed to pay on deposits.

In Kenya, there has been negative association between inflation and commercial banks lending volumes and base lending rates. This is because as inflation increases, the commercial bank lending volumes in Kenya declines. Conversely, there exists positive relationship between the base lending rates and inflation rates. As inflation increases, so does the base lending rates (Economic Survey, 2013). The study sought to establish if similar trend occurs in Kenya Commercial Bank Limited.