Effective Interest Rate and Financial Performance of Commercial Banks in Kenya

Purpose: The collapse of some of the commercial banks in Kenya has sparked concerns over the financial performance of the banking industry in Kenya. Due to this challenge, stakeholders, including creditors, depositors, employees, and investors, have incurred huge financial losses. Interest rates are crucial macroeconomic indicators that significantly influence the cost of capital and borrowing for firms. Understanding how interest rates affect the financial performance of commercial banks holds significance for investors, policymakers, and corporate decision-makers. The study sought to establish the effect of effective interest rates on the financial performance of commercial banks in Kenya. Methodology: ROA was used as a metric to measure financial performance. The study was guided by the Loanable Funds Theory. The study population comprised all 39 commercial banks in Kenya, employing a descriptive research design utilising a comprehensive dataset spanning ten years, from 2015 to 2024, comprising financial statements of commercial banks in Kenya and interest rate data from the Central Bank of Kenya. A census method was adopted. Data was encoded and processed using statistics software (STATA version 18). Descriptive statistics were produced for all the numerical data. Inferential statistics were employed using the panel regression model. The results were presented using tables. Findings: The study revealed the R2 value of 0.412, implying that 41.2% of the variations in the perceived financial performance can be explained by the variations in the effective interest rates, while factors not studied in this research contribute 38.8% of the variance in the dependent variable. Panel regression results concluded that effective interest rates have a positive and significant effect on the financial performance of commercial banks in Kenya, with a coefficient value of 0.03910. Unique Contribution to Theory, Practice and Policy: The study recommended that commercial banks in Kenya and CBK should promote interest rate frameworks that enhance transparency, risk-based pricing, and competitiveness across the banking sector. The study recommends policies that encourage banks to optimise effective interest rates through ethical incorporation of fees and compounding structures, while ensuring full disclosure to borrowers.