EFFECT OF INTEREST RATE CAPPING ON LOAN VOLUMES OF COMMERCIAL BANKS IN KENYA PATRICK KIPKURUI KIPSANG A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF SCIENCE IN FINANCE, SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI NOVEMBER, 2019 DECLARATION I, the undersigned, declare that this is my original work and has not been presented to any institution or university other than the University of Nairobi for examination. Signed: _____________________Date: __________________________ PATRICK KIPKURUI KIPSANG D63/71204/2014 This research project has been submitted for examination with our approval as the University Supervisors. Signed: _____________________Date: __________________________ DAN CHIRCHIR Lecturer, Department of Finance and Accounting School of Business, University of Nairobi Signed: _____________________Date: __________________________ DR. CYRUS IRAYA Senior Lecturer, Department of Finance and Accounting School of Business, University of Nairobi ACKNOWLEDGEMENT To God, who made all this possible. All glory unto him. I sincerely acknowledge my supervisors, Dan Chirchir and Dr Cyrus Iraya, first and foremost, for agreeing to be my supervisors. I am grateful for their systematic guidance constructive criticism, open door policy and above all for the time and effort as they supervised me throughout the project process. I also thank the university administration for providing a conducive environment in reference to infrastructure and other support that was directly or indirectly linked to the study. Thank you to all my friends who contributed to the completion of this academic document both directly and indirectly. They provided me with logistical and moral support that gave me every reason to work harder and ensure that this study becomes a success. DEDICATION This project paper is dedicated to family, who have always encouraged and supported me throughout my life. They have been, and still are, the pillar of strength in my life. I thank you. To my friends, finishing this project would have been impossible if it were not for your constant impetus in concluding this project. Also for your wonderful support and great input, you are much appreciated. TABLE OF CONTENTS DECLARATION ........................................................................................................................... ii ACKNOWLEDGEMENT ............................................................................................................ iii DEDICATION .............................................................................................................................. iv LIST OF TABLES ....................................................................................................................... vii ABREVIATIONS AND ACRONYMS ..................................................................................... viii ABSTRACT ................................................................................................................................... ix CHAPTER ONE ............................................................................................................................ 1 INTRODUCTION ......................................................................................................................... 1 1.1 Background of the Study ....................................................................................................... 1 1.1.1 Interest Rate Capping ..................................................................................................... 2 1.1.2 Loan Volumes ................................................................................................................ 3 1.1.3 Interest Rate Capping and Loan Volumes ...................................................................... 4 1.1.4 Commercial Banks in Kenya .......................................................................................... 6 1.2 Research Problem .................................................................................................................. 7 1.3 Research Objective .............................................................................................................. 10 1.4 Value of the Study ............................................................................................................... 10 CHAPTER TWO ......................................................................................................................... 11 LITERATURE REVIEW ........................................................................................................... 11 2.1 Introduction ......................................................................................................................... 11 2.2 Theoretical Framework ........................................................................................................ 11 2.2.1 Loanable Funds Theory of Interest Rates ..................................................................... 11 2.2.2 Classical Theory ........................................................................................................... 12 2.2.3 Financial Repression Theory ........................................................................................ 13 2.3 Determinants of Loan Volumes ........................................................................................... 14 2.3.1 Interest Rates ................................................................................................................ 14 2.3.2 Inflation ........................................................................................................................ 15 2.3.3 Economic Growth ........................................................................................................ 16 2.3.4 Firm Specific Factors ................................................................................................... 16 2.4 Empirical Review ................................................................................................................ 18 2.4.1 Global Studies .............................................................................................................. 19 2.4.2 Local Studies ................................................................................................................ 20 2.5 Conceptual Framework ........................................................................................................ 23 2.6 Summary of the Literature Review ..................................................................................... 23 CHAPTER THREE ..................................................................................................................... 24 RESEARCH METHODOLOGY ............................................................................................... 24 3.1 Introduction ......................................................................................................................... 24 3.2 Research Design .................................................................................................................. 24 3.3 Population ............................................................................................................................ 24 3.4 Data Collection .................................................................................................................... 24 3.5 Data Analysis ....................................................................................................................... 25 3.5.1 Analytical Model .......................................................................................................... 25 3.5.2 Diagnostic Tests ........................................................................................................... 26 3.5.3 Tests of Significance .................................................................................................... 29 CHAPTER FOUR ........................................................................................................................ 30 DATA ANALYSIS, RESULTS AND DISCUSSION ................................................................ 30 4.1 Introduction ......................................................................................................................... 30 4.2 Descriptive Statistics ........................................................................................................... 30 4.3 Diagnostic Tests .................................................................................................................. 32 4.3.1 Multicollinearity Test ................................................................................................... 32 4.3.2 Autocorrelation Test ..................................................................................................... 33 4.3.3 Heteroskedasticity Test ................................................................................................ 33 4.3.4 Stationarity using ADF Test ......................................................................................... 34 4.4 Correlation Analysis ............................................................................................................ 35 4.5 Regression Analysis ............................................................................................................ 36 4.6 Discussion of Research Findings ......................................................................................... 38 CHAPTER