Interest Rate Risk and Financial Performance of Commercial Banks in Kenya

Abstract

The purpose of the study was to determine the effect of interest rate risk on the financial performance of commercial banks in Kenya. The study adopted a positivist research philosophy. An explanatory research design was applied. Secondary data was collected from 38 commercial banks. Primary data was also collected using a structured questionnaire from a sample of 386 senior bank managers selected through stratified and simple random sampling methods. The findings of the study regarding interest rate risk showed moderate agreement among respondents (mean scores 3.48), with regression analysis indicating a significant negative association with the financial performance of commercial banks (β=-0.297; p<0.05 for primary data; β=-0.326 p<0.05 for secondary data), leading to rejection of the null hypothesis. It was concluded that interest rate risk is significantly associated with the financial performance of commercial banks in Kenya. The results underscore the significance of robust interest rate risk management practices to enhance financial resilience and optimising performance in a dynamic economic environment. Commercial banks need to continuously monitor the interest-earnings ratio and diversification of their income sources to minimise exposure to interest rate risk in case of fluctuations and or market distortion. The financial performance was measured primarily using Return on Assets, which may not comprehensively capture the overall performance of commercial banks. Other indicators, such as Return on Equity, Net Interest Margin, and earnings per share measures, could provide additional insights into profitability and shareholder value. Similarly, interest rate risk was operationalised using interest income sensitivity/volatility, yet interest rate risk is multidimensional and may also be reflected through repricing gaps, duration gaps, maturity mismatches, and interest rate spreads.