Impact of Interest Rate Spread and Risk Premium on Lending on Domestic Credit to Private Sector in Kenya
Abstract:
The Kenya financial sector has been characterized by varying interest rate spreads and risk premiums, which may have impacted the flow of domestic credit to the private sector, but whose exact impact is inadequately understood. While banks maintain substantial interest spreads to cover operational costs and risks, these spreads combined with risk premiums could potentially constrain credit expansion to private sector. Despite the critical role of do mestic credit in driving private investment and consumption, there is limited empirical evidence on how changes in interest spreads and lending risk premiums impact credit allocation to Kenya's private sector. The study employed autoregressive distributed lag modelling approach, using yearly time series data from 1990 to 2023, to establish the short and long run impacts that interest spread and risk premium on lending have on domestic credit to the private sector. Data was sourced from the World Bank website. The finding show that interest spread had a positive insignificant impact on domestic credit to private sector in the long run. However, in the short run interest rate spread exhibited negative and significant impact on domestic credit to private sector. On risk premium on lending, the findings show that it exerted negative significant impact on domestic credit to private sector both in long run and short run.
