The Impact of macroeconomic variables on non-performing loans in Kenya: an analysis of interest rates and exchange rates

Abstract

This study investigates the impact of macroeconomic variables on non-performing loans (NPLs) in Kenya’s banking sector. Using a panel dataset spanning five years and encompassing multiple commercial banks, the research evaluates the influence of critical indicators such as interest rates, exchange rates, bank size, and loan loss ratios. The study employs a fixed-effects regression model to analyze the relationships between these variables, with robust standard errors used to address heteroskedasticity. The findings reveal that certain macroeconomic variables, notably the exchange rate and interest rate, exhibit significant effects on NPL levels. A depreciating exchange rate correlates with a higher proportion of NPLs, reflecting increased repayment challenges for foreign-denominated loans. Conversely, higher interest rates exacerbate the cost of borrowing, further contributing to loan defaults. The role of bank-specific factors, such as loan loss ratios, also emerges as significant, suggesting that internal financial management practices compound the broader macroeconomic pressures on credit quality. This study contributes to the growing body of literature on the nexus between macroeconomic stability and financial sector performance in developing economies. The findings underscore the need for policymakers and regulators to align monetary and fiscal policies to foster a stable macroeconomic environment while encouraging sound credit risk management practices in banks. By addressing both systemic and institutional factors, this research provides actionable insights into mitigating the persistent challenge of non-performing loans in Kenya.