THE EFFECTS OF INTEREST RATE CONTROL ON BORROWING OF MONEY (LOAN)

CASE STUDY EQUITY BANK 1.1 BACKGROUND TO THE STUDY

Interest rate control is a concept used by the central bank to control the amount of money in circulation. The aim is usually to: 1. Discourage borrowing from commercial banks thereby reducing the amount of money in circulation when it is in excess of a certain limit 2. Encourage borrowing from commercial banks thereby increasing the amount of money in circulation when it is below a certain limit There are a number of strategies employed by the central bank to achieve this: 1. Bank rate/Discount rate Commercial banks usually resort to borrowing from the central bank whenever they have a shortage of funds. A high bank rate charged means that the commercial banks will also have to charge high interest rates thereby discouraging borrowing by individuals. On the other hand if the bank rate is low it implies that commercial banks are in a position to charge lower interest rate on the loans advanced to individuals thereby encouraging borrowing. 2. Moral suasion In this strategy, the central bank implores commercial banks to lower the interest rate that they charge on loans advanced to borrowers. This has the effect of encouraging borrowing of loans when the interest rates are reduced. 3. Compulsory Deposit The central bank keeps varying the levels of compulsory deposit from time to time. This has the effect of regulating the amount of money available to the commercial banks which they can issue to loan seekers. When the compulsory deposit is increased, banks have relatively less money to lend and they then tend to increase interest charged on these loans thus discouraging borrowing. On the other hand when the compulsory deposit is reduced, banks will have more money to lend and will therefore reduce the interest rates they charge consequently encouraging borrowing. 4. Open market operation The central bank buys or sells government bonds with the aim of controlling the short term interest and by extension the money supply in the economy. When the central bank wants to reduce the money in the market, it sells these bonds. This has the effect of encouraging borrowing from commercial banks. On the
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other hand, to increase the money in the market the central bank buys these bonds from the public. This has the effect of discouraging borrowing since there is enough money in circulation. 5. Liquidity ratio The central bank determines the liquidity ratio that commercial banks are required to maintain. Whenever the central bank wants to curb the ability of commercial banks to advance loans to borrowers, it lowers the value of liquid assets that the commercial banks can maintain. This means that commercial banks will have fewer assets that they can readily convert to money. Since they have less money they therefore tend to increase interest rates thus discouraging borrowing .Conversely to increase the ability of commercial banks advancing money to borrowers, the central bank increases the value of liquid assets that commercial banks are required to hold. This means they have a lot of assets that can easily be converted to cash that can be given to borrowers. This means that they are likely to have more money to lend. They therefore decrease interest rates charged on loans thereby encouraging borrowing which consequently increasing the amount of money in supply. 6. Cash ratio The central bank will from time to time vary the amount of money that commercial banks are required for their normal operations. This has the effect of regulating the amount of money that is available to the commercial banks to advance as loans to their customers. In situations where the central bank wants to discourage borrowing, the cash ration is raised so that less money is available for lending. Conversely, to encourage borrowing, the central bank, the central bank will reduce the cash ratio so that more money is then available for lending by the commercial banks to their customer and subsequently increase the money in circulation. This study is intended to point out the effects of interest rate control on borrowing from the commercial banks. It endeavors to point out whether the effects of interest rate control (if any) have been achieved as intended by the central bank. We point out whether this policy has achieved the intended purposes.

You have been doing a good job so far. However, there are a few things you must never forget.

1. Always present the background of the problem in paragraph form. Resist the temptation to number. Keep it prose. 2. CITATIONS ARE A MUST. What you have done constitutes plagiarism.

Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.6" + Indent at: 0.85"

1.2 STATEMENT OF THE PROBLEM

The interest rate control policy has not been effective in controlling the borrowing of money in Kenya. Despite the measures put in place by the central bank, borrowing of money in Kenya has not been regulated as is reflected by the high inflation rates that have continued to rise therefore putting into doubt the effectiveness of these measures. Could have said more . If you review literature more, you find gaps which you justify here

1.3 PURPOSE AND OBJECTIVE OF THE STUDY 1.3.1 GENERAL OBJECTIVE

The general objective is to study the effects that have been produced by interest rate control measures put into place by the central bank.

1.3.2 SPECIFIC OBJECTIVES

To determine if the interest rate control measures put in place by the central bank has produced the desired effects. Tryh always at least three for a masters proposal

1.4 RESEARCH QUESTIONS AND HYPOTHESIS 1.4.1 RESEARCH QUESTIONS

1. Has interest rate control produced any effects on borrowing patterns in Kenya? 2. Has interest rate control produced the desired effects on the borrowing patterns in Kenya?

1.4.2 HYPOTHESIS
Ho: Interest rate control has no effect on borrowing of money. Ho: Interest rate control has not produced the desired effects as intended by the central bank on borrowing of money.

1.5 SIGNIFICANCE OF THE STUDY

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This study aims to explain whether there are any effects on borrowing that result from interest rate control. The study also aims to show why despite the interest rate control measures put in place by the central bank, the borrowing of money has not been effective as evidenced by the ever increasing levels of inflation. To the government/central bank This study will point out the effects of the interest rate control methods employed by the central bank if any. It will show if the methods were effective and whether they can be improved to achieve the desired effects.

To the commercial banks This study will give a chance for any flaws to be corrected. The commercial banks can then liaise with the central bank in streamlining these strategies. This will save the commercial banks from disruptions that arise from the central bank changing policy from time to time. The commercial banks can also be in a position to provide the required amount of credit to borrowers at stable rates. To the loan borrowers This study will upon implementation stabilize the high rates of inflation thus saving them from losses that are accrued as a result of inflation. This also has the effect of ensuring that the right amount of credit is always available to borrowers.

1.6 LIMITATIONS OF THE STUDY

This study is faced with many challenges. The main ones are: 1. Access to information and data that is relevant to the study. Many banks keep their information with high secrecy. This means that accessing enough information on this subject is a big challenge. 2. Diversity of the Kenyan economy. This implies that the effects that result from interest rate control are not uniform across the country and that different regions will react differently to this policy. The findings of this study might not be a reflection of the entire country from people of all walks of life.

1.7 ASSUMPTIONS OF THE STUDY

Several assumptions are made in this study: 1) Interest rate control measures have been put in place by the central bank appropriately to take care of high/low levels of borrowing money from commercial banks. 2) It is assumed that commercial banks offer loans to borrowers at the same interest rates. 3) The central bank institutes interest rate control measures in a timely and swift manner to regulate the borrowing patterns. 4) Interest rate control is applied uniformly to all the Kenyan banks at the same time across the country.

1.8 XX

1.9 DEFINITIONS OF THE TERMS

I. Central bank This is a financial institution that manages a nations currency, money supply and interest rates. Commercial bank This is a type of financial institution that provides transactional, savings and accepts deposits from the public. Interest rate control Is a concept/mechanism used by the central bank and by extension the commercial banks to raise/lower the interest rates charged on loans to individual borrowers thus influencing the borrowing patterns Bank rate/Discount rate
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II.

III.

IV.

This is the amount of interest charged on the loans that are advanced to commercial banks by the central bank. V. Compulsory Deposit This is the amount of money that commercial banks are required to maintain with the central bank. Open market operation This is the activity of the central bank buying or selling or buying government bonds on the open market. Liquidity ratio This is the ratio of liquid assets to the other assets that the bank is holding. Cash ratio This is the amount of money that commercial banks are required to hold for their normal operations. Interest rate This is the rate at which interest is paid by a borrower for the use of money they borrowed from the lender.

VI.

VII.

VIII.

IX.

2.1 LITERATURE REVIEW 2.1.1 THEORITICAL LITERATURE 2.1.2 EMPIRICAL LITERATURE

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