Profitability of commercial banks in kenya: does interest rate spread matter?

Abstract

Banks have witnessed a declining profitability, as characterized by their trend on the return on assets and return on equity. Between the years 2012 and 2018, the industry registered a fall on ROA by 1.9 percentage points from a high of 4.7% to a low of 2.8%. Equally the ROE decreased by 6.3 percentage points from a high of 30% to a low of 23.7%. The legislation on Banking Act 2016 introduced interest rate capping and have not borne the desired effect on stimulating access of credit to private sector. The study sought to empirically analyze the relationship on commercial banks profitability, interest rate spread and macroeconomic determinants in Kenya. The study used a one-step GMM estimation technique on panel data for the 30 commercial banks between years 2004 to 2018. The data used in the study was obtained from Central Bank of Kenya, World Development Indicators and Kenya National Beaureu of Statistics publications. The study results indicated that interest rate spread is positive and statistically significant at 1% level of significance on tier one and tier two bank’s profitability, but negatively affects profitability for the tier three banks. The lagged profitability was positive and statistically significant across all the tier banks. GDP was found to have positive but not statistically significant on tier one banks profitability but was negative and statistically significant to tier two banks profitability at 10% level of significance. Inflation had a positive relationship on the tier one banks. The study also established a positive relationship on real interest rates across all the tier banks performances. Money supply was observed to have a positive effect on profitability to all the tier banks. The study recommends that the government through CBK, should work on an efficient monetary policy to ensure the Central Bank Rate, which is a component of interest charged by commercial banks is always at its minimum. This will ensure commercial banks’ price their loans at reasonable rates after consideration on their risk and profit margins. On the other hand, it proposes formulation of bank management policies that will counter over reliance on interest rates margins and become more market oriented to spur a sustainable banks performance.