In Kenya, there has been negative association between inflation and commercial banks’ loaning volumes and base rates on lending. This is due to the fact that as inflation increases, the commercial bank loaning volumes in Kenya declines. Conversely, there exists positive relationship between the base rates on lending and inflation rates. As inflation increases, so does the base rates on lending. The study sought to establish if similar trend occurs in Kenya Commercial Bank Limited.

The Banking industry in Kenya is governed by the Companies Act, the Banking Act, the Kenya’s central bank Act and the several prudential guidelines issued by the CBK. The banking sector was liberalized in 1995 and exchange controls lifted. Kenya‘s financial system is among the largest and more developed in sub- Saharan Africa, with a large banking sector. The banks, non-banking finance institutions, microfinance institutions and building societies are supervised by the Kenya’s central bank (James, 2010). CBK played an important role in formulating and implementing monetary policy directed at achieving and maintaining low inflation as one of its key principal objective (Ndung’u and Ngugi, 2013).

Since its establishment in 1966, the CBK has used monetary targeting framework to pursue the inflation objective. The monetary policy strategy has been and continues to be based on the presumption that money matters, that the behavior of monetary aggregates has major bearing on the performance of the economy particularly inflation. Although commercial banks’ rates on lending are determined by numerous factors outside the CBK’s control, the Monetary policy committee which is the key policy organ of the central bank notes that structural alteration or changes in the deposit and credits markets, including introduction of development banking products, can play a significant role in influencing a downward trend in the commercial bank rates on lending.

In Kenya, the average rates on lending have been reducing from a figure of 19 percent in the year 2002 to an average of 13 Percent over the last five years commercial bank’s average rates on lending declined from 13. 74 percent in December 2006 to 12. 56 per cent in October 2015 there are a number of factors that have influenced the rates on lending including inflation, government policies, the macroeconomic variables and banks specific factors such as return on investment and covering cost of operation.

Loaning is the most important services that commercial banks do render their customers, in other word banks grant advances and loan to individuals, government and business organization. Commercial banks are the most important savings, mobilization and financial resource allocations institutions, consequently these roles make them an important phenomenon in economic growth and development. In performing this role, it must be realized that banks have the potential, scope and prospects for mobilizing financial resources and allocating them to productive investments. Therefore, no matter the sources of the generation of income or the economic policies of the country, commercial banks would be interested in giving out loans and advances to their numerous customers bearing in mind, the three principles guiding their operations which are, profitability, liquidity and solvency.

Chodechai (2004) while investigating factors that affect interest rates, degree of loaning volume and collateral setting in the loan decision of banks, under notes that Banks have to be careful with their pricing decisions as regards to loaning as banks cannot charge loan rates that are too low due to the revenue from the income from interest will not be enough to cover the cost of deposits, general expenses and the loss of revenue from some borrowers that do not pay. Moreover, charging too high loan rates may also create an adverse selection situation and moral hazard problems for the borrowers. However, commercial banks decisions to lend out loans are influenced by a lot of factors such as the prevailing interest rate, the volume of deposits, the level of their domestic and foreign investment, banks liquidity ratio, prestige and public recognition to mention a few. Interest rate is the amount charged as percentage of principal by a lender to a borrower for the use of assets based on the risk level that is the compensation for the loss of asset’s use by the lender. Inflation is a key determinant of commercial banks’ rates on lending globally. According to Santoni (1986), inflation depreciates the value of money such that a percentage increase in inflation results into a similar percentage fall in value of the country’s currency. Broadly, inflation theorists attribute inflation to monetary causes and mal adjustments in economic system. The performance of commercial banks has been a considered issue in the developing countries. This phenomenon is attributed to the crucial role of the commercial banks in the economy. Further, the performance of banking is important to depositors, owners, potential investors and policy makers as banks are the effective facilitators of monetary policy of the government. This suggests that the volumes of bank loaning may partly depend on the performance of commercial banks.

Taner (2013) study on the effects of inflation uncertainty on credit markets reveals that unpredictable inflation raises interest rates, decreases loan supply and affect loan demand. This therefore suggests that an increase in inflation may raise the bank rates on lending and lead to low bank loaning volumes. Emon (2012) confirms this assertion and states that lenders are very aware that inflations erodes the value of their money over the time period of a loan, so they increase the interest rates to compensate for the loss. The increased interest rates may therefore influence the borrowing patterns for any commercial bank. This also suggests that there is a positive relationship between the inflation rates and the rates on lending even though the extent to which one affects the other for different time periods is not certain.

According to Mishkin and Collins (1995) inflation lenders or depositors who pay a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings while their borrowers benefit. A positive effect of inflation is derived from debt relief where debtors who have debts with a fixed nominal rate of interest will see a reduction in the real interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate. Therefore if one takes a loan, with an interest rate of 15% and the inflation rate is at 5% the real interest rate that one will pay for the loan is 10%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of loaning the money by creating a higher initial stated interest rate or by selling the interest at a variable rate. Kenya statistics shows that inflation had been on the rise hitting a roof mark of 29. 4% in November 2011 up from 28. 4% in October same year. Inflation rate dropped to 20. 50% in September 2010 from 26. 30% in December 2011. However the latest month’s statistics show that inflation rate has dropped to 7. 76% in October 2013 from 8. 29% in September 2013. Loaning has become quite costly as lenders leading to high interest rate as compensation for the devalued currency they will be repaid in the future. High rates of inflation lead to inefficiency in a market economy and, in the medium to longer term, result in a lower percentage of economic progression. Price increases are inclined by the amount of currency in circulation, and productivity of the different financial divisions. The Kenya’s central bank regulates the growth of the total money stock to a level that matches a predetermined economic growth target as specified by Kenya Government and outlined in its Financial Policy Statement.

Roshaneh (2011) indicated that the profit spread of borrowers is affected with the rise in prices as a result of inflation which consequently affects their borrowing power. Overall, Generally speaking, reimbursing of credits by the borrower will be exorbitant in this way stressing their accessible monetary assets in the predominant financial conditions which may make some default in installments. Huybens and Smith (1999) contend that an increase in the rate of inflation could have at first negative results on monetary part performance through credit showcase gratings before influencing financial development. Indeed, advertise gratings involve the proportioning of credit, which diminish middle person action and capital arrangement. The decrease of capital venture impacts contrarily both on long haul monetary development and value showcase action. Different researchers and specialists have conveyed our examination attempts to attempt and recognize the connection between loan repayment, interest for credit office, loan costs, and budgetary performance in both business and miniaturized scale fund establishments, among numerous different ideas. Okoth (2013) completed an exploration on the impact of loan fee and inflation rate on exchange rates in Kenya. He presumed that inflation in loan fee is important to settle the conversion scale deterioration and to control the inflationary weight and along these lines stays away from much antagonistic monetary outcome. Thulani (2012) consider examined the connection among inflation and loan cost spread in Kenya and the degree to which the Fisher impact theory holds. The examination found that inflation had a long haul association with loan cost.

The past investigations, for example, Liu et al. (2000), Ubide (1997), Leheyda (2005) and Khan et al. (2006) have tended to the determinants of managing an account rates on lending and performance and utilization of fiscal approach by the national banks to control currency markets. An investigation by Pattnaik and Mitra (2011) shows that financing costs, inflation rates and exchange rates are generally exceptionally corresponded. By controlling loan costs, national banks apply impact over both inflation and exchange rates, and changing financing costs affect inflation and currency values. Kiptoo (2007) found that the real exchange rate is acquired by changing the nominal exchange rate with inflation differential between the household economy, and outside exchanging accomplice economies. Bett (2013) investigated contribution of loaning interest rates on SACCOS performance in Kenya. The findings by Bett (2013) were that loaning interest rate of commercial banks is positively correlated with profitability. This implies that interest rate and profitability move together without impacting adversely demand of loanable funds.

In any case, in spite of the many research work, in Kenya the impact of inflation on credit reimbursement conduct in commercial has not been enough looked into. It is in this light this examination will analyse impacts of inflation on loan repayment behaviour in Kenya.