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EFFECT OF INTEREST RATES ON LOAN DEMAND IN EQUITY BANK: (2014-2017)

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The importance of commercial banks in an economy is well known and so, their success and contribution to individuals and agencies in regard with financial services is something significant. In liberalized financial sector, one of the expected benefits is the narrowing of the interest rate spreads, i.e. the difference between the interest rate charged to borrowers and the rate paid to depositors (Folawewol & Tennant, 2008). Thus, wide deposit-lending interest rate margin could be indicative of banking sector inefficiency or a reflection of the level of financial development. The issue at hand is that, most countries in Sub Saharan Africa (SSA) are still confronted with high levels of interest rates, despite having undertaken structural adjustment reforms that led to the liberalization of interest rates in several countries in the region. In Uganda, the banking sector plays a dominant role in the financial sector, particularly with respect to mobilization of savings and provision of credit (Nampewo, 2013). However, the ever fluctuating interest rates more so, high rates seem to be affecting borrowers and economy at large.

Interest rate is thus defined as a rate which is charged or paid for the use of money (Turner, 2013). It is also viewed as the price paid for use of loaned funds. According to Ddumba (2011), ever since Bank of Uganda increased the Central Bank Rate to a staggering 23% from 13% in 2010, banks took advantage of the situation and hiked their prime lending rates accordingly. For instance, Stanbic Bank increased its lending rate to 34%, Centenary Bank from 19% to 23%, the once Crane Bank from 23% to 28%, dfcu bank from 23% to 27%, Standard Chartered from 18% to 34%, Barclays Bank from 17.5% to 30% and KCB from 18% to 28%. This situation has become a critical concern in the banking and lending industry in Uganda. Financial institutions have been accused of charging high interest rates and exploiting the consumers. This necessitated for the government through the Ministry of Finance passing a Financial Institutions Act with an aim of protecting the consumers.

In regard to loan demand, it is argued that when loans seem expensive as a result of high interest rates, the level of loan demand in commercial banks tend to be low. Rising and falling of interest rates directly affects consumer and personal financial decisions. Rising interest rates make saving relatively more attractive and borrowing relatively more expensive. Falling interest rates have the opposite effect. To borrowers, when interest rates are low, potential borrower would take up more loans and this would lead to decrease in price as the market for real assets improves (Ingram, 2011). This is because they find it relatively easy to repay their debt. When interest rates are high, people are reluctant to borrow because repayments on loans cost more. It is a widely shared argument that, interest rates are the only primary source of income for commercial banks however, high interest rates tend to have a negative effect on loan demand. If loan demand falls it equally affects the financial objectives of the bank. It becomes a paradox or a puzzle to gain competitiveness by increasing interest rates at the expense of falling loan demand.

In Uganda, during 2008 and 2009, several existing banks went on an accelerated branch expansion either through mergers and acquisition or through new branch openings and this was recorded to be the highest growth in the years. As far as October 2012, there were 24 licenced commercial banks in Uganda, with nearly 500 bank branches and a total of almost 600 automated teller machines (Bank of Uganda, 2013). Equity Bank Uganda (EBU) is among the commercial banks competing to have a share of this trade. EBU offers a full range of financial services, comprising savings, credit and money transfer. The reason for Choosing EBU is due to the fact that it is still struggling to deepen its services within Uganda.  According to the Financial Report 2012 on Assets and Market share among some commercial Banks in Uganda, out of the 12 list of commercial banks, EBU was at the bottom with 135 million dollar assets, 2.2% Market share and 44 branches compared to Stanbic Bank 1,213 million dollar assets, 19.9% market share and 91branches.  In this study however, focus is on determining the extent to which interest rates have affected loan demands at EBU.

1.2 Statement of the Problem

High interest rate spreads have continued to persist among commercial banks in Uganda which have affected loan demand levels by potential borrowers. As a result, commercial banks such as Equity Bank have experienced disturbing upshots following the rising interest rates. According to the article on 24th August, 2017 in Daily Monitor, it was revealed that, in 2016, loan interest rates were capped at 400 basis points above the signal rate, currently at 10 per cent and deposit rates at a floor of 70 per cent of the Central Bank’s rate. This resulted into an interest margin of seven per cent. In this respect, the growth of credit to the private sector fell further to 2.1 per cent over the 12 months to May 2017, according to CBK data; this was blamed on the rate caps. Though Equity Bank boasted of a client base of 11.7m however, in 2017 it announced a 7.4 drop in net profit. Consequently, the banks’ lending to micro, small and medium enterprises (MSMEs) fell by an estimated 5.7 per cent between August 2016 and April 2017. Findings by Standard Investment Bank (2017) revealed a decline in micro loan book; with the loss ratio, meaning that the bank was not pricing risk. Though the bank had forecasted full-year group loan book growth of five per cent, however, a significant drop from realised five-year average loan growth of 24.4 per cent was registered (SIB, 2017). It is upon aforementioned problems that have prompted the researcher to conduct this study.

1.3 Objectives of the Study

1.3.1 General Objective

To determine the effects of interest rates on loan demand: a case of Equity Bank,

1.3.2 Specific Objectives

The specific objectives of this study are

To establish the long run relationship between interest rates and loan demand in Equity Bank

1.4 Research Questions

The study will be guided by the following questions:

1. What is the long run relationship between interest rates and loan demand in Equity Bank?

1.5 Scope of the Study

1.5.1 Content Scope

The study is confined at determining the effects of interest rates on loan demand in commercial banks in Uganda using Equity bank.

1.5.2 Geographical Scope

Geographically, the study will be conducted at Equity Bank; this bank is specifically selected because of accessibility and its staggering financial performance.

1.5.3 Time Scope

The study will be carried out for a period of four years from 2014-2017.

1.6 Significance of the Study

This study is expected to benefit the following stakeholders:

It is expected that generated data may be used by policy makers such as Central Bank and Ministry of Financial and Economic Development in formulating policies to address existing gaps that account for high loan charges.

It is also expected that, commercial banks among other financial institutions may use the generated information in form of recommendations to improve on their policies to suit their clients.

Furthermore, it is expected that the generated data may add useful and updated information to already existing literature.

Finally, the study is expected to serve as a point of reference for future studies by students and other scholars who may wish to conduct similar studies.

CHAPTER TWO

LITERATURE REVIEW

2.0 Introduction

This chapter will review past literature written about the study and specifically about relationship between interest rates and loan demand.

2.1 Relationship between interest rates and loan demand

2.1.1Interest Rates

Interest rates, it may be argued, may perhaps be the single most key motivation that influences credit markets and the access to issuance of credit facilities by lending institutions. The Monetary Policy Committee usually sets the benchmark lending rate on a monthly basis, and commercial banks reference this is setting out the interest rates to issue out credit at to the markets. Since the early 1990’s up to August 2016, there was a liberal interest rates regime in the country, whereby banks would determine their preferred basis point above the set out rate by the MPC. However, since September 2016, this has changed, as banks a required by law to set out their interest rates at a maximum of four basis points above the base rate set by the MPC.

2.1.2 Credit Risk

This refers to the risk that arises when a comparison of non-performing loans Vis a Vis the total loans issued is done. Coyle (2000) defines credit risk as the loss suffered due default in the repayment of credit granted to customers, this can be done intentionally or due to one just not being able to pay back what is owed, and according to the terms of agreement. Banks closely monitor this ratio with a view of taking corrective action in cases of adverse outcomes. If the ratio goes up, then banks will raise up the interest rates charged to borrowers in order to cushion themselves against losses, and if the ratio goes down, then banks may lower interest rates. Banks may also limit credit issued out to risky clients when the ratio is high, and may be open to issuing out more credit when the ration is low, thus opening up opportunity to more riskier client’s.

2.1.3 Liquidity Risk

Watanabe (2012) argues that a banks weaker (stronger) balance sheet such as a poorer (greater) capital adequacy and lower (higher) liquidity has a positive effect on the banks’ lending rate, as this may help the bank push down on the rate of interest that will be charged to customers, hence able to attract more customers, issuing more loans as opposed to the vice versa whereby higher rates of interest would draw away customers.

2.1.4 Operating Costs

Were and Wambua (2013) argued out that a rise in  the operational expenses and  costs of commercial banks will have an effect of driving up interest rates in an effort by the banks to cover up as much of the operational costs as possible. The higher the rates of interests charged, the more potential customers are driven further away, and this may severely limit the amount of credit issued out by commercial banks. When the interest rates lower, demand for credit goes up, and commercial banks may be in a position to issue more credit. Lower operating costs translating to lower interest rates on the other hand will have the positive impact of opening up an opportunity for more customers to access credit facilities, and this will drive up the levels of credit advanced by commercial banks.

Credit drives economic activities usually by enabling businesses, households and other economic entities to have investments that are beyond their cash on hand. Individuals and households are able to do purchasing without having at present all the entire cost of their purchase. Saunders (2010) explains that the driver of economic growth is the demand for loanable funds, as this enables individuals as well as institutions to undertake productive economic activities even when they don’t have enough funds or savings. Governments also seek for credit from both local and international sources in order to fund infrastructure and development projects, as well as to meet other rising obligations. Financial markets are the key providers for credit in any market and economy. They provide a protection to investors, households and governments against urgent and abrupt needs for funds. Financial institutions are central and at the core of the economy as they offer to provide liquidity both through offering line of credit and offering demand deposits that offer withdrawal at any given time.

According to Amonoo et al., (2003), credit helps in the bridging of the gap that may exist between enterprise owner’s financial assets and what may currently be the required financial assets an enterprise. As in most instances there exists an imbalance between the two, then forcing a demand of credit by enterprises. According to Aryeetey et al., (1994), categorization of demand for credit can be put into three; demand that is perceived, potential demand and demand that is revealed. Demand that is perceived may arise in situations whereby enterprises that assume to be in need of finances mention cash as a constrain. On the other hand, Potential demand may arise in instances whereby an imperfection in the markets and institutions make it impossible to actualize the desire for credit. Demand that is revealed is the written application for financial support based on a given rate of interest prevailing at the time of application. Gale (1991) defines effective demand as what lending institutions are willing and able to disburse to borrowers.

There has been a continuous and endless debate on what really is the impact that interest rates have on the level of personal loans advanced by commercial banks and other financial institutions. Besley (1994) argued that loan seekers may face adverse selections occasioned by high interest rates. Financial institutions charge individuals perceived as being of higher risk and higher rates in order to cover for default risk. There are however, those who differ and argue that the rates of interest charged do not have an impact on levels of personal loans advanced or demanded in an economy. According to Aryeetey et al., (1994), the level of interest rates was not a major concern for SME’S seeking credit from financial institutions.

According to Pandula (2011) and Carreira (2010) banks may prefer certain sectors having lower risks and defaults, high growth rates and high cash flows. Lending decisions are highly influenced by the policies and procedures laid down by banks (Burns, 2007). According to Yehuala 2008, borrowers may be put off by lending terms that are too stringent, even when viable investment opportunities are available to them. Besley (1994) indicates that interest rates may end up affecting the average quality of lenders loan portfolios, as well as playing an allocated role in that they may equate demand and supply for loanable funds.

Interest rate restrictions are among the oldest and most prevalent forms of economic regulation (Glaeser and Scheinkman, 1998, 1). Studies about the effects of the regulation to payday loans have been mainly studied in United States, where states can independently regulate the payday markets. Pew Charitable Trusts (2012) have identified three categories of state payday loan regulation. Permissive states are least regulated and allow initial fees of 15 percent of the borrowed principal or higher. Hybrid states are a little more tightly regulated, having rate cap, restrictions on the number of loans or allowing multiple pay periods for borrowers to repay the loan. Restrictive states prohibit or have price caps low enough to eliminate payday lending in the state. Restrictions in United States are not directly comparable to the restrictions made in Finland, but similarities between the regulations of instant and payday loan markets can be found.

Various studies with different viewpoints have been conducted related to interest rate regulation. DeYoung and Phillips (2013) has made an extensive study on interest rate restrictions on payday loan market in Colorado for a seven-year period. Results from the study indicate that the prices of the loans moved towards the price ceiling over time. The strategies in payday loan market changed during the period, from competitive low prices, towards more strategic pricing depending on location and target group. Rigbi (2013) found out in his research that interest rate restrictions do not deliver the outcomes that have been their main premise. Although higher interest rate limits have only slightly increased the interest which borrower must pay compared to cases with more stringent regulation of interest rates (Rigbi, 2013, 23). On the other hand, some of the researchers have discovered that interest rate restrictions have effectively decreased the price of consumer credit (Peterson, 1979, 39-40, Termin and Voth, 2008, 755). Can be said, that the effects of restrictions on interest rate vary, and depend on the severity and the way of implementing the restrictions

Price regulation has been found to affect the supply of credit. DeYoung and Phillips (2013, 144) stated that the reduction of competition is part of the reason of rising prices in certain payday loan markets. In Australia, the interest rate cap based on maximum annual percentage rate of 48 percent, has been found to decrease the number of instant loan providers in states where the cap is in force (Government of Australia, 2011, 59). In addition, The Oregon policy change, entering force July 2007, constrained consumer loans under $50,000, capping the fees and charges of $100 loan to approximately $10, with minimum loan term of 31 days. Six months prior to the policy change, there were 346 licensed loan providers. The number dropped to 105 providers seven months after the change and further to 82, approximately a year after the policy change (Zinman, 2008, 6).

Overall, interest rate restriction has not been found to substantially reduce consumer lending (iff/ZEW, 2010, 238). Termin and Voth (2008, 744) observed in their study, that the stricter interest rate limit creates discrimination among borrowers, favouring high income individuals and cutting off smaller borrowers bearing higher risk. Also, Study made by Villegas (1982, 953) concludes with an argument that by imposing rate ceilings, high-risk borrowers are prevented from obtaining a loan and going into debt. Further, in Zinman’s (2008) study, the before and after activity of lending was compared between Oregon and Washington, where only the first mentioned state implemented the cap. Results of the study show that payday borrowing decreased by 26 to 29 percentage points compared to Washington. Borrowers compensated the payday loans with other, more expensive credits (Zinman, 2008, 10). On the other hand, increasing the rate cap has increased the probability of granting the loan (Rigbi, 2013, 1).

Interest rate regulations do not only affect the availability, but also the product range in the market. Countries with strict interest rate regulation tend to have fewer different credit products in the market compared to countries with looser or non-existent regulation (iff/ZEW, 2010, 231-232). Termin and Voth (2008, 744, 750) discovered that average loan size and minimum loan size increased strongly. Also, preferences towards indirect, such as commodity- related credit increased if restrictions were strict. This is because such credit can be discounted and retailers absorb part of the risk (Peterson, 1979, 40).

Interest and price regulation causes various effects in the credit market. In many cases, effects are dependent on the regulatory approach. Low and moderate regulations may end up non-existent, whereas highly regulated market can cause significant changes. Especially in instant loan market, the pressure for regulation is enormous. Borrowers in the instant loan market have been found to be vulnerable and the products very expensive. Nevertheless, interest rate restrictions regulate the amount lenders can charge from the borrowers, considering the credit risk the borrowers may have. Regulations define if the market is profitable and in worst case scenario, small loans cease to exist.

The consumer loan portfolio of Finnish households was about 14 billion in August 2015, of which the share of short-term loans was around 100 million (Suomen Pankki 2015, SVT 2015). Short-term financial need is usually fulfilled by using credit card or instalments, since getting a small loan from a bank might be time consuming and not available for everyone. Short-term loans were invented to fill that gap, to provide the small financial aid which was troublesome to obtain. There is no official legal term for short-term loan in Finland, but among legal scholars and legislators the definition of Määttä (2010, 265) is used where the short-term loan is quickly achievable, unsecured, less than three months, minor consumer credit, and which is attainable via internet or text message. The amount of short-term loan is typically from around 20 euros to couple hundred euros, and the price is based on fixed costs rather than variable interest rate. Obtaining the credit through computer or mobile devices is easy and fast, and the loans are not bound on buying commodities. Depending on the amount of loan and payback time, the annual percentage rate varies from around 200 to over 1000 percent (Valkama, Muttilainen, 2008, 14). In terms of annual percentage rate, short-term loans are very expensive compared to conventional consumer credit. Before the interest rate cap, the average APRC of short-term loans averaged 920 percent (HE 78/2012).

Credit card is considered as a form of consumer credit granted by the bank or financial company. The amount is unsecured and starts from one thousand euros, which the consumer can use to pay the bills. Depending on the lender, the cost of credit varies. The cost consists of the credit interest including the reference rate and the marginal, annual fee, and billing fee. Payment of the loan is possible in installments or in full by the due date of the credit. The interest rates of credit cards vary from less than ten percent to a few tens of percent (Suomen rahatieto, 2017).

To obtain a credit card, the consumer should be adult, have fixed income and no payment default entries. (Danske bank, 2017)

Another way to finance short-term needs is through hire purchase. Hire-purchase refers to a system by which one pays for a commodity in regular installments from which one or more of the installments is paid after the commodity is handed over to the customer. Further, the seller has reserved the right to take back the commodity or hold the ownership until the commodity is paid (CPA, 38/1978, 7:7). Pricing in Hire-purchase is similar to the one in credit cards and the requirement for fixed income is common.

Municipalities in Finland have voluntary option to give social credit to inhabitants. The purpose of social credit is to prevent economic exclusion, over-indebtedness, and encourage independent living. Target group for this service is low income, underprivileged individuals, who are otherwise excluded for getting a reasonable loan, but who can pay back the social credit (Ministry of Social Affairs and Health, 2017, Makkonen, 2010, 118). Considering the financial situation of municipalities, cost of credit and the amount of work required to provide such services, the target group of social credits is narrow. Social credit should be considered as a part of social security rather than free financial markets.

Closely related product to short-term loans is called a payday loan which is popular in United States. In traditional payday loan, the borrower will write a future dated check to the lender. For example, a check for 235 dollars in exchange for 200 dollars, which the borrower gets in advance. Usually the period for the check is two weeks or until the borrower’s next payday, when the lender gets the borrowed amount back and a reward of 35 dollars. In many cases, the borrowers pay only the financial charge, renewing the loan for another two weeks. Similarities to the Finnish short-term loans are that the loan is granted fast, it is unsecured and for a short period, and high annual percentage rate of charge. Unlike the short-term loans in Finland, payday loans are usually acquired from offices, or in other words, pawnshops. Payday lending is a relatively new business: At the beginning of 1990s, there were less than two hundred payday loan offices but in 2001 the number was already about 10000 (Caskey, 2002). Similarities among the products of consumer credit are short time period, pricing strategy and the use of the product. Social credit is very limited form of credit and available only for few people. Credit cards and hire purchases require fixed income, and in many cases an assurance before it is granted. That is why they cannot be considered as a direct alternative for instant loan. Compared to more traditional form of consumer credit, instant loans take advantage of technology, which makes the granting and taking a loan simple and fast.

2.2 Conceptual Framework

Independent Variables                                                                        Dependent

Variable

Figure 2.1: Conceptual Framework

Summary of Literature review

It is evident from the review of literature that much has been done on the issue of interest rates and their relationship to levels of credit issued and commercial banks levels of non-performing loans, locally and internationally as well.

For example, Njenga and Wanyoike (2014) studied of the effects of risk factors on unsecured loans, while the research done by Were and Wambua (2013) focused on factors that are bank-specific, and which play a major role in the determination of a bank’s interest rates spread.. Kimutai and Jagongo (2013) focused on what influences commercial banks in Kenya on credit rationing.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1       Introduction

In this chapter, a discussion on the research design, the population of the study, the description of the population, methods of data collection, as well as data analysis methods is done.

3.2       Research Design

This is a plan which offers guidance to a researcher on how to organize their research activities (Bryman & Bell 2003). This study will adopt quantitative methods of data collection. This is a research design that attempts to identify a causative relationship between an independent variable and a dependent variable (Kumar, 2009). The independent variable will be interest rate and loan demand as dependent variable.

3.3       Data type and source

The study used purely secondary data to analyse data findings. This was in form of reports on the bank’s loan disbursed and interest rates charged for the period under review.

3.3.1 Secondary data

Secondary sources describe, discuss, interpret, comment upon, analyze, evaluate, summarize, and process primary sources. Secondary source materials can be articles in newspapers or popular magazines, book or movie reviews, or articles found in scholarly journals that discuss or evaluate someone else’s original research.

3.4 Variables and their measurements

3.5       Data Analysis

Data analysis will be used through univariate and bivariate to determine the relationships and correlations using ANOVA whereby Y=Ժ+βχі

CHAPTER FOUR

4.0 Trend of loan demand

Source: Secondary Data

The graph above shows that the trend of loan demand was highest at 2016 January this indicates that loan demand keeps on changing basing on the level of interest rates in the country at the time . this figure further shows that loan demand is not constant showing that if interest rate is low loan demand is high and when the interest rates are high loan demand is high. This findings is also in line with watanabe (2012) who asserts that Interest rates  may be argued, may perhaps be the single most key motivation that influences credit markets and the access to issuance of credit facilities by lending institutions. The Monetary Policy Committee usually sets the benchmark lending rate on a monthly basis, and commercial banks reference this is setting out the interest rates to issue out credit at to the markets.

This findings is also further in line with Amonoo et al., (2003) who indicates that because of the unpredictability of interest rates there is always a constantly changing loan demand since when the interest rates are high the demand for loans decreases and vice versa.

Normality test

A regression was run and on clicking on the view-residual test-histogram-normality test, the histogram is bell-shaped, suggesting a normal curve shape, and the jarque-bera statistics has high p-value of greater than 0 indicating that the errors in the regression are normal that is to say; the statistics probability of 0.361311 is greater than zero and it has a percentage of 36% greater than 10%(36%>10%) thus the errors in the regression are normal.

Unit root test of the series 1^st difference

Ho:  Loan demand has a unit root

Ha:  Loan demand has no unit root

At first difference, absolute of the ADF t-statistic was found to be greater than that of the 5% critical value. Its P-value was also found to be less than 0.05, thereby rejecting the null hypothesis and concluding that Loan Demand has no unit root at first difference and is therefore stationary.

Descriptive statistics of loan demand on interest rates from 2015-2017

This involved establishing the basic descriptive statistics and the correlation matrix. The descriptive statistics of all the variables are displayed while the correlation matrix in table 4.3 demonstrates the relationship between loan demand and interest rates.

Source:

The Jarque-Bera tests the hypothesis that the series is normal. Since the probability value for loan and interest are less than five percent significant level, the null is accepted meaning the series is normal.

Co-integration tests

Among the variables that are integrated of order 1(1), an attempt was made to check whether Cointegration holds. The purpose of the Cointegration tests was to determine whether a linear combination of a group of non-stationary series is stationary. Engle and Granger (1987) pointed out that a linear combination of two or more non- stationary series may be stationary. The linear combination of loan demand and interest rates was checked to find out whether the residuals were stationary.

Table showing: Co-integration tests output

The next attempt involved testing the residuals for the order of integration. The application of the Augmented Dickey Fuller test statistic revealed that the residuals are stationary in levels. This confirmed that the linear combination of loan demand and interest rates is indeed stationary.

Correlations

Source: Primary Data

The results show a weak negative relationship between loan demand and interest rates this findings therefore indicates that increase in interest rates leads to a decrease in loan demand this is also in line with Were and Wambua (2013) who argued that a rise in the interest rates by the banking sector increases cost of credit this therefore leads to a decline in the loan demand because borrowers can’t afford to pay high interest rates. The higher the rates of interests charged, the more potential customers are driven further away, and this may severely limit the amount of credit issued out by commercial banks. When the interest rates are lower, demand for credit goes up, and commercial banks may be in a position to issue more credit.

Forecasting loan demand for 2018 and 2019

The forecast revealed a steady decrease in loan demand in December 2019 as compared to January 2018.

Graphical representation of the forecast between 2018 and 2019

Findings from the study indicates that loan demand will decline in 2018 and 2019 this results therefore shows that equity bank should lower the interest rates in order to enable it reverse this situation from happening.

REGRESSION ANALYSIS OF

The results above show that the R Square is 0.112 (11.2%) which implies that interest rates affects loan demand as interest rates increases, loan demand decreases and in this case therefore it is likely that the increase in interest rates at one time led to a decrease in loan demand. However, there are other factors that loan demand such availability of liquidity, the political environment, and the regulatory environment among others. For example availability of liquidity in bank affects loan demand if it is low, the bank reduces on the money it lends out in order to have more; the political climate/environment forces banks to lend to few customers because of the risks that they perceive may affect their business and the regulatory environment affects the amount of money lent.

CHI-SQUARE TEST

The chi-square test showed that it is 0.067 likely that interest rates affect the loan demand. This implies that as loan demand goes high the interest rates reduce and thus this confirms that there is a long run relationship between interest rates and loan demand.

CHAPTER FIVE

CONCLUSION AND POLICY RECOMMENDATION

INTRODUCTION

CONCLUSION

LONG RUN RELATIONSHIP BETWEEN LOAN DEMAND AND INTEREST RATE

The results further showed that the R Square is 0.112 (11.2%) which implies that interest rates affects loan demand as interest rates increases, loan demand decreases and in this case therefore the increase in interest rates at one time lead to a decrease in loan demand. However, there are other factors that loan demand such availability of liquidity, the political environment, and the regulatory environment among others.   For example availability of liquidity in bank affects loan demand if it is low, the bank reduces on the money it lends out in order to have more; the political climate/environment forces banks to lend to few customers because of the risks that they perceive may affect their business and the regulatory environment affects the amount of money lent.

The chi-square test showed further with P value of (0.067) the interest rates affects the loan demand. This implies that loan demand depend on interest rates as few people demand for loan,  the interest rates increases.

The forecast shows that loan demand will reduce from 53,616,666,667/= in 2017 to 49,980,555,556/= in 2018 and reduce further to 49,765,740,741/= in 2019 and the interest rates will further increase to 22.91% in 2018 from 22.08% in 2017 to 22.96% in 2019%. The reduction in loan demand may be due to reduced economic activity.

The findings furthermore agrees with Were and Wambua (2013) argued out that a rise in  the operational expenses and  costs of commercial banks will have an effect of driving up interest rates in an effort by the banks to cover up as much of the operational costs as possible. The higher the rates of interests charged, the more potential customers are driven further away, and this may severely limit the amount of credit issued out by commercial banks. When the interest rates lower, demand for credit goes up, and commercial banks may be in a position to issue more credit. Lower operating costs translating to lower interest rates on the other hand will have the positive impact of opening up an opportunity for more customers to access credit facilities, and this will drive up the levels of credit advanced by commercial banks.

Interest rates, it may be argued, may perhaps be the single most key motivation that influences credit markets and the access to issuance of credit facilities by lending institutions. The Monetary Policy Committee usually sets the benchmark lending rate on a monthly basis, and commercial banks reference this is setting out the interest rates to issue out credit at to the markets. Since the early 1990’s up to August 2016, there was a liberal interest rates regime in the country, whereby banks would determine their preferred basis point above the set out rate by the MPC. However, since September 2016, this has changed, as banks a required by law to set out their interest rates at a maximum of four basis points above the base rate set by the MPC.

The findings furthermore agree with according to Amonoo et al., (2003), credit helps in the bridging of the gap that may exist between enterprise owner’s financial assets and what may currently be the required financial assets an enterprise. As in most instances there exists an imbalance between the two, then forcing a demand of credit by enterprises.

The findings furthermore agree with According to Aryeetey et al., (1994), categorization of demand for credit can be put into three; demand that is perceived, potential demand and demand that is revealed. Demand that is perceived may arise in situations whereby enterprises that assume to be in need of finances mention cash as a constrain. On the other hand, Potential demand may arise in instances whereby an imperfection in the markets and institutions make it impossible to actualize the desire for credit. Demand that is revealed is the written application for financial support based on a given rate of interest prevailing at the time of application. Gale (1991) defines effective demand as what lending institutions are willing and able to disburse to borrowers.

There has been a continuous and endless debate on what really is the impact that interest rates have on the level of personal loans advanced by commercial banks and other financial institutions. Besley (1994) argued that loan seekers may face adverse selections occasioned by high interest rates. Financial institutions charge individuals perceived as being of higher risk and higher rates in order to cover for default risk. There are however, those who differ and argue that the rates of interest charged do not have an impact on levels of personal loans advanced or demanded in an economy. According to Aryeetey et al., (1994), the level of interest rates was not a major concern for SME’S seeking credit from financial institutions.

RECOMMENDATION OF RESULTS

In light of the above, the respondents recommended the following

That the central bank should intervene in the financial market and reduce on the interest rates as banks charge their own rates thus cheating unsuspecting customers.

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The results above shows that

Source: primary data

Co-Integration

Interest Rates

Correlegram

Findings on