The Effect of Interest Risk Volatility on The Financial Performance of Tier Iii Banks in Kenya
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Abstract: Tier III banks in Kenya have not been stable in their performance because they are exposed to system risks like the volatility of interests. These are banks that mainly reach small businesses and low-income earners, and they cannot take a lot of shocks in changes in credit expenses. This paper has investigated how interest rate volatility impacted the performance of Tier III banks in Kenya in the years 2004-2024. The key performance indicator used was Return on Assets (ROA). The sources of secondary data included Central Bank of Kenya (CBK), Kenya National Bureau of Statistics (KNBS) and the published financial statements of the 22 Tier III banks. Descriptive statistics revealed that the interest rates were between 6 and 18 with the mean of 9.46 and a standard deviation of 2.54, which revealed great volatility. During the same time, ROA was 1.1 on average, ranging between -0.41% and 2.37 with not all years showing positive returns. Correlation analysis showed that there was a weak positive relationship between interest rates and ROA (r = 0.191), which indicated that an increase in interest rates increased net interest margins temporarily. Regression analysis, however, revealed that ROA had a negative and slightly significant correlation with interest rates (= -0.003111, = 0.056), which meant that increased rates eventually caused the bank to become less profitable. The explanatory power of the model was R2 = 0.117 with a total significance of F = 4.12 (p = 0.056). The results showed that there could be short-term positive outcomes on lending rates as it could increase interest income, but the long-term impact of interest rate volatility was a negative outcome on the financial performance of Tier III banks in the form of higher loan defaults and decreased credit uptake. The research concluded that interest rate volatility has been a major risk issue that was weakening the stability of small banks in Kenya. It suggested that the CBK should take up the stable interest rate policies and Tier III banks must enhance credit risk management, diversify their income sources as well as the capital buffers to survive the volatility.
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