Interest rate caps can have far-reaching consequences on the composition and maturity of commercial bank loans and deposits. From both a policy and research standpoint, it is important to understand the mechanisms behind such impacts and the channels through which they affect various players in the financial sector.
While cross-country evidence suggests that interest rate caps can reduce credit availability and increase costs for low-income borrowers1, rigorous micro-evidence on the channels of impact within an economy is missing.
In a new working paper that uses bank-level panel data from Kenya, Mehnaz Safavian and I carefully examine the impact of the recently imposed interest rate caps on the country’s formal financial sector.2
In September 2016, the Kenyan Parliament passed a bill that effectively imposed a cap on interest rates charged on loans and a corresponding floor on the interest rates offered for deposit accounts by commercial banks. This new legislation was in response to the public view that lending rates in Kenya were too high, and that banks were engaging in predatory lending behavior. The interest rate caps were therefore intended to alleviate the repayment burden on borrowers and improve financial inclusion as more individuals and firms would be able to borrow at the lower repayment rates.