January 2015 to February 2016 representing the pre-downturn period; February 2016 to October 2016 representing the interim period prior to the caps; and October 2016 to September 2017 representing the one-year period after the caps for which data are analyzed in this study.<sup>2</sup> Several important findings emerge from the quantitative analysis. First, the data confirm a statistically significant decline in aggregate lending in the Kenyan economy, with a 3.1% decline after February 2016 from an aggregate base of Ksh. 167.65 billion (US $1.64 billion) in the pre-February 2016 period, and a further 2.7% decline after the interest rate caps. Correspondingly, there is a sizable increase in Non-Performing Loans (NPLs), with the size of abnormal loans seeing an increase of almost 53% after February 2016 from an aggregate base of Ksh. 25.67 billion (US $0.25 billion), and an additional 8% after the caps. The increase in NPLs is exhibited across nearly every major sector in the economy.

This precipitous rise in NPLs is reflective of both the prevailing economic and market downturn as well as the interest rate caps. Our microeconomic analysis finds that after the caps, commercial banks started issuing loans of shorter maturity, thus likely contributing to the increase in NPLs. Furthermore, according to two recent Central Bank of Kenya (CBK) Commercial Banks’ Credit Surveys for the second and third quarters of 2017, the upward trend in NPLs was expected to continue into the fourth quarter of the year and beyond due to the political uncertainty and economic downturn in the country. The CBK surveys further confirm commercial banks responded to these changes by elevating their risk mitigation measures, effectively rationing out many small and unsecured borrowers. As a result, 54% of the respondents revealed that interest rate caps had negatively affected their lending to SMEs.

Our data analysis confirms that commercial banks indeed responded to the interest rate caps by shoring up their corporate clients. Both tier 1 and tier 2 banks exhibited a significant flight towards corporate clients after the interest rate caps, which came at the expense of lending in other sectors such as SME loans.

Tier 3 banks exhibited a flatter trend initially but an eventual flight to corporate clients after the interest rate caps. These banks also sharply reduced their SME lending. Our discussions with counterparts suggest that tier 3 banks were relatively less successful in immediately shoring up their corporate books, as these clients were taken up by higher tier banks. Instead, the smaller tier 3 banks were forced to maintain their portfolios in SME and consumer lending, but, as the data show, with time even smaller banks reduced lending to the SME sector.

The analysis also focuses on debt maturity and deposit composition to understand changes in the types of products offered by commercial banks after the interest rate caps. While tier 1 and tier 2 banks expanded their long- and medium-term loan books, likely signifying their desire to fulfill demand from good quality clients, tier 3 banks were the only ones that exhibited an increase in short-term loan offerings. These changes in debt maturity likely have negative

> 2 The bill was signed in August 2016, and came into full effect in mid-September 2016.

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