Analysing High Interest Rate Spreads: Empirical Evidence From The Kenyan Banking Sector

Abstract

Banking industry plays a crucial part in growth and development of an economy. Banks/financial institutions mobilize funds from depositors and channels them to borrowers for investment. Efficient banking industry is imperative for economic development because of its role of mobilizing resources for investment purposes. Interest rate spread is a major indicator of the banking sector efficiency. Kenya has very high interest rate spreads which is a major challenge not only to financial deepening but, economic growth as well. Existing literature on the determinants of interest rate spread is inconclusive and hence, this study sought to investigate further on whether bank, industry and macro-economic specific factors explain the high interest rate spreads within the Kenyan banking sector. Regression approach based on Ho and Saunders (1981) was applied to a panel data of 38 commercial banks covering the period 2006-2015. Results were analysed based on Pooled OLS, random and fixed effect model estimations. The size of the bank, return on average assets, reserve requirements and real Gross Domestic Product were found to be significant factors determining interest rate spreads. The study recommended the need to explore both internal and industry-led strategies to reduce the effects of some of the bank specific factors which are driving high interest rate spreads in Kenya. Additionally, even though there is high competition in the banking sector, there is need to enhance it further so as to reduce interest spreads.