The Effects of Interest Rate Spread and Financial Performance of Commercial Banks in Kenya

Abstract

Commercial banks have a crucial role in the allocation and distribution of economic resources on a global scale. Interest rates play a crucial role in shaping the financial landscape of commercial banks and are significant factors influencing the financial performance of banks. The relationship between interest rate spread and the financial performance of financial institutions is widely recognized, indicating that both short-term and long-term interest rates impact the net interest margins of commercial banks. The main objective of this study was to examine the effect of interest rate spread on the financial performance of commercial banks in Kenya. The study was based on the loanable funds theory and liquidity preference theory. The study used a descriptive research design to examine the relationship between the study variables. A total of 37 commercial banks were studied giving an 88.1% response rate. The study utilized secondary data collected from various sources, including reports from the Kenya Bankers Association, the Kenya Central Bank, and financial statements. This dataset encompasses a period from January 2018 to December 2022, comprising 185 observations. The study employed a comprehensive methodology that encompassed descriptive statistics, correlation analysis, and regression analysis. Pearson correlation indicated a positive and significant relationship between interest rate spread and financial performance. The R Square value indicates that about 40.3% of the variation in ROA can be explained by the combination of the selected independent variables. The ANOVA results indicate statistical significance at the 5% level, as evidenced by the significant F statistic (P < .05). The analysis also revealed that interest rate spreads have a significant and positive effect on ROA. Bank size also demonstrated a strong and positive correlation with ROA. Additionally, asset quality was identified as a crucial factor, with a significant negative correlation. The study concludes that interest rate spreads, bank size, and asset quality are pivotal determinants of commercial bank performance in Kenya. The study recommends that policymakers focus on promoting an environment where healthy interest rate spreads can coexist with transparent and competitive practices. Strategies to support growth and efficiency among banks should be balanced with prudent risk management. Bank executives should invest in advanced credit risk assessment technologies, and training programs should enhance risk management skills among bank staff. Future research should consider the influence of macroeconomic factors, and conduct cross-country comparisons to provide a more comprehensive understanding of bank performance dynamics