Factors affecting pricing of loanable funds by commercial banks in Kenya
Matete, John Kennedy
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Pricing of loanable funds without a proper rationale or framework leads to uncertainty and unpredictability on the incidence of the next or expected interest rate. The uncertainty and unpredictability lead to high interest rates to cover for any eventual loss. High interest rates may lead to high cost of capital, low investment, reduction in aggregate supply of goods and services and a vicious circle that reduces economic growth. It also reduces credit availability and increase the risk of speculation and adverse selection. These problems result in lower standard of living due to reduced disposable income. The specific objectives of the study were: to examine how changes in wealth influence pricing of loanable funds by commercial banks in Kenya. Secondly, to examine how expected return on bonds relative to alternative assets influence pricing of loanable funds by commercial banks in Kenya. Third, to examine how liquidity of bonds relative to alternative assets influence pricing of loanable funds by commercial banks in Kenya. Fourth, was to examine how risk of bonds relative to alternative assets influence pricing of loanable funds by commercial banks in Kenya. Fifth was to examine how government short-term borrowings influence pricing of loanable funds by commercial banks in Kenya. And lastly, was to examine how changes in expected inflation influence pricing of loanable funds by commercial banks in Kenya. A descriptive cross sectional survey research design was used to collect qualitative and quantitative data. A census of forty three commercial banks in Kenya that were in operation by 2006, was carried out to gather information on the issues in the sector pertaining to setting lending rates on loanable funds. Primary data was collected using a questionnaire, administered through interview schedules to commercial banks and to the central bank. Data collected was analysed by use of multiple regression. Applying the loanable funds model, changes in wealth, expected inflation and government borrowing were found to be significant predictors of lending rates. Liquidity of bonds relative to alternative assets (treasury bills), risk of bonds to alternative assets and expected return of bonds to alternative assets were not significant predictors of lending rates. The study recommends; that to improve changes in wealth (demand and supply for bonds market); the government should review laws and regulations applicable to collective investment vehicles for people to increase participation in bonds as vaible invetsment assets. The government should develop automated trading systems to encourage access by onshore and offshore investors. And the government should promote a common infrastructure (settlement system, central securities depository, trading systems). For government short-term borrowing, the Central Bank of Kenya should ensure there is a proper debt restructuring strategy together with ample liquidity in the system. The government through the Central Bank of Kenya should ensure wider diseminnation of the information on inflation to the public through various channels of communication available.