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Essay / Effects of inflation on commercial bank lending in Kenya
In Kenya, there has been a negative association between inflation and commercial bank lending volumes and base rates on loans. This is because as inflation increases, commercial bank lending volumes in Kenya decline. Conversely, there is a positive relationship between base rates on loans and inflation rates. As inflation rises, so do base rates on loans. The study aimed to determine if a similar trend was occurring in Kenya Commercial Bank Limited. Say no to plagiarism. Get a tailor-made essay on “Why violent video games should not be banned”?Get the original essayThe banking sector in Kenya is governed by the Companies Act, the Banking Act, the Central Bank of Kenya Act Kenya and the several prudential directives issued by the CBK. The banking sector was liberalized in 1995 and exchange controls lifted. Kenya's financial system is one of the largest and most developed in sub-Saharan Africa, with a large banking sector. Banks, non-bank financial institutions, microfinance institutions and building societies are supervised by the Central Bank of Kenya (James, 2010). The CBK played an important role in the formulation and implementation of monetary policy aimed at achieving and maintaining low inflation as one of its main objectives (Ndung'u and Ngugi, 2013). Since its inception in 1966, the CBK has used a monetary targeting framework to pursue its objectives. the inflation target. Monetary policy strategy is and continues to be based on the assumption that money matters and that the behavior of monetary aggregates has a major influence on the performance of the economy, particularly inflation. Although commercial bank lending rates are determined by many factors beyond the control of the CBK, the Monetary Policy Committee, which is the key policy body of the central bank, notes that alterations or structural changes on the deposit and credit markets, including the introduction of development banking products, can play an important role in influencing a downward trend in commercial bank lending rates. In Kenya, average lending rates have been reduced from a low of 19 percent in 2002 to an average of 13 percent over the past five years. Over the past few years, average commercial bank lending rates have declined from 13.74 percent in December 2006 to 12.56 percent in October 2015. A number of factors have influenced lending rates, including inflation, government policies, macroeconomic variables and the specifics of banks. factors such as return on investment and coverage of operating costs. Lending is the most important service that commercial banks render to their customers, in other words, banks provide advances and loans to individuals, government and commercial organizations. Commercial banks are the most important institutions for saving, mobilizing and allocating financial resources; therefore, these roles make it an important phenomenon in economic growth and development. In fulfilling this role, it must be understood that banks have the potential, reach and outlook to mobilize financial resources and allocate them to productive investments. Therefore, irrespective of the sources of revenue generation or economic policies of the country, commercial banks would be interested in extending loans and advances to their numerous clients inkeeping in mind the three principles that guide their operations, namely profitability, liquidity. and solvency. Chodechai (2004), while studying the factors that affect interest rates, degree of loan volume and definition of collateral in the lending decision of banks, notes that banks should be careful in their pricing decisions in regarding loans, because banks cannot charge for loans. rates that are too low because of interest income will not be enough to cover the cost of deposits, overheads and the loss of income for some borrowers who do not pay. Additionally, charging loan rates that are too high can also create a situation of adverse selection and moral hazard problems for borrowers. However, the decisions of commercial banks to grant loans are influenced by many factors such as the prevailing interest rate, the volume of deposits, the level of their domestic and foreign investments, the liquidity ratio of the banks, their prestige and their public recognition, to name just a few. The interest rate is the amount charged as a percentage of principal by a lender to a borrower for the use of assets based on the level of risk which constitutes compensation for the lender's loss of use of the asset. Inflation is a key determinant of commercial bank lending rates globally. According to Santoni (1986), inflation depreciates the value of currency such that a percentage increase in inflation results in a similar decline in the value of the country's currency. Generally speaking, inflation theorists attribute inflation to monetary causes and inappropriate adjustments of the economic system. The performance of commercial banks is a matter of concern in developing countries. This phenomenon is attributed to the crucial role of commercial banks in the economy. Furthermore, the performance of the banking sector is important to depositors, owners, potential investors and policy makers, as banks are effective facilitators of government monetary policy. This suggests that bank lending volumes may depend in part on the performance of commercial banks. Taner's (2013) study on the effects of inflationary uncertainty on credit markets finds that unpredictable inflation increases interest rates, decreases the supply of loans, and affects the demand for loans. This therefore suggests that an increase in inflation could increase bank rates on loans and lead to low bank lending volumes. Emon (2012) confirms this assertion and states that lenders are very aware that inflation erodes the value of their money over the life of a loan, so they increase interest rates to compensate for the loss. Rising interest rates can therefore influence the borrowing habits of any commercial bank. This also suggests that there is a positive relationship between inflation rates and lending rates, although the extent to which one affects the other over different periods is unclear. According to Mishkin and Collins (1995), lenders or depositors who pay a fixed interest rate on loans or deposits will lose purchasing power on their interest income while their borrowers will benefit. A positive effect of inflation arises from debt relief, in which debtors whose debts carry a fixed nominal interest rate will see a reduction in the real interest rate as the rate of inflation increases. The “real” interest on a loan is the nominal rate minus the inflation rate. Therefore, if one takes out a loan with an interest rate of 15% and the rate.