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

1.2 Statement of the Problem

Commercial banks in Kenya have been struggling with fluctuating borrowing by both retail and corporate customers (KBA, 2013) Kenya Commercial Bank is not exceptional to this phenomenon yet there is no known empirical study to show whether the fluctuations may be due to high lending rates, or are occasioned by inflationary forces. Economic Watch (2010) states that in most developed economies such as the United States of America, commercial banks‟ keep the interest rates on lending equal to the inflation rate. However, when the inflation rate rises, the financial institutions issuing  debt instruments would need to lure investors with a higher interest rate. The study did not find out what would happen to the new lending volumes when inflation increases. According to Ralf et al. (2000), in Germany, lending rate is a key factor in the commercial bank lending policy such that when commercial bank lending volume decreases shows some correlation between bank loans and interest rates, the commercial banks‟ profitability on lending is depressed. This suggests that the number of new loan applicants is also suppressed. Barajas et al. (1999) study on the determinants of interest

rates identified the interest rates as a factor that determines loan volumes in Colombia while Ziramba (2008) study on “Bank lending, expenditure components and inflation in South Africa” confirms this assertion and states that there exist correlation between bank loans and lending rates.

Thulani (2012) study investigated the relationship between inflation and interest rate spread in Kenya and the extent to which the Fisher effect hypothesis holds. The study utilized annual time series data for the fifteen year period starting from the year 1997 to the year 2011. The study found that inflation had a long term relationship with interest rate. The previous studies such as Liu et al. (2000), Ubide (1997), Leheyda (2005) and Khan et al. (2006) have addressed the determinants of banking lending rates and performance and use of monetary policy by the central banks to control money markets. From these previous studies, it is evident that none of the studies investigated the effects of inflation on Kenya Commercial Bank new lending volumes. This study attempted to bridge the gap by determining the effects of inflation on Kenya Commercial Bank lending volumes and rates with specific focus on new loans annually for a period of ten years.

1.3 General Objective

The general objectives of this study were to determine the effects of inflation on commercial bank lending with specific focus on the Kenya Commercial Bank Limited.

1.4 Specific Objectives

1.4.1 Determine the relationship between annual inflation rate and KCB base lending rate from the year 2004 to 2013

1.4.2 Establish the relationship between annual KCB new lending volumes and both inflation rate and base lending rate from 2004 to 2013

1.4.3 Establish the relationship between KCB annual loan default volumes and inflation rate from 2004 to 2013

1.5 Significance of the Study

The outcome of the study will provide necessary information to the following key stake holders:

1.5.1 Kenya Commercial Bank LTD

Lending is one of the key functions of KCB as a bank and contributes a reasonable amount of revenues for the business, The study would therefore help them understand how the inflation rate fluctuation pattern is affecting the banks overall lending volume and loan default rate thus prompt the senior management to look into ways of navigating it either through policy change in order to maximize their earnings.

1.5.2 Commercial banks in Kenya

The study will provide commercial banks with the basis for explaining some of the factors that contribute to the changing patterns in lending volumes by the commercial banks in Kenya. It may also trigger the commercial banks to innovate new policies on bank lending that are attractive to the borrower.

1.5.3 Researchers and Academicians

The study will contribute to the body of knowledge hence will be of interest to both researchers and academicians who seek to explore or investigate the contribution of inflation rate on Commercial Banks‟ lending pattern in Kenya and thereby lay a foundation for carrying out further related studies.

1.6 Scope of the Study

The research was limited to Kenya Commercial Bank and mainly focused on the effects of inflation on commercial bank lending in Kenya. The study used and analyzed both Primary data and Secondary data. The primary data was obtained from sample key informant employees drawn 15 branches within Nairobi County and secondary data on inflation provided by The Kenya National Bureau of Statistics for the last Ten years 2004 to 2013, bank lending rates annual lending volumes and annual loan defaults rate from Kenya Commercial Bank for same period 2004 to 2013.

1.7 Definition of Terms

1.7.1 Inflation

Inflation is the persistent increase in a nations general prices levels (Caprio & Summer, 2003)

1.7.2 Interest rate/Lending rate

Interest rate is the rate at which interest is paid by the borrower for the use of money that they borrow from the lender. Interest rates are normally expressed as a percentage rate over the period of one year. (Marcus et al. 2012)

1.7.3 Lending volumes

Lending volumes refers to amount of financial resources that the borrower is able to obtain from the lender. (Greene and Villanueva, 1991)

1.7.4 Investment

Something that an individual or institution is willing to spend their financial resources on now because it will give them benefits in the future. (Marcus et al. 2012)

1.7.5 Bank

A company which carries on or proposes to carry on banking business in Kenya (The banking Act, 2010)

1.8 Chapter Summary

Chapter one provides the background information about the research by addressing both global and domestic perspective of the prevailing situation. It pinpoints the problem to be addressed and the purpose of the study. The significance of the study has been addressed in the chapter and the scope of the study where timeframe and limitation of the study was discussed as limited to Kenya Commercial Bank.

The next chapter, literatures review on effects of inflation on lending was discussed, followed by chapter on methodology used to carry out the study. Consequently discussion on findings from the research held in chapter four. Finally, chapter five dwelt with conclusions and recommendations related to this study.