Determinants of interest rate spread in commercial banks in Kenya
Mimi, Edith W
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The determinants of IRS are classified into three segments namely bank specific factors, industry factors and macroeconomic factors. Bank Specific Factors.This are factors that affect an individual bank such as bank size, liquidity ratio of a bank, operating costs, non-performing loans, return on asset, structure of the balance sheet and non-interest income.The market structure of banking sector in respect of the internal organization, management, regulatory framework and their contributions in terms of creating an incentive for resource mobilization by rewarding investors and encouraging competition for deposit are some of the factors that could determine the spread. An analysis of bank interest rate spreads is therefore central to the understanding of the financial intermediation process and the macroeconomic environment in which banks operate. The objective of the study was to determine the relationship between interest rate spread and its determinants in commercial banks in Kenya. This was a descriptive study which was applied to a population of 43 commercial banks. Secondary data was collected from commercial banks’ audited annual financial reports on bank size, credit risk, operating costs, liquidity risk and return on assets. The data was analyzed using multiple linear regression analysis. The study found that bank size had a negative effect on interest rate spread, though insignificant. Owing to increased performance as read from ROA statistics, bank size also increased over the years. Correlation analysis shows that there was negative overall linear relationship between bank size and interest rate spread. The findings that higher spreads can be interpreted as an indicator of inefficiency, thus positive relationship between bank size and interest rate spreads; thus, big banks are less efficient. The results are not surprising given that big banks are associated with market power they control a bigger share of the market both in terms of deposits and loans and advances. They also enjoy good reputation and trust (perceived to be more stable, reliable, well-managed, among other positive attributes) and hence can easily mobilize deposits even at lower rates and attract higher loan demand even at higher rates. The findings also shows that when inflation was at its highest in interest rate spread was highest also at its highest 2009.However, correlation analysis shows that this relationship was insignificant established that where the lending rates are high and borrowers have no options for raising capital, the goods and services produced from the money borrowed have to factor in the high cost of the capital. The borrowers which are, at times, corporations, have to service the loans and retain a markup, the goods and services sold are more expensive because the entire cost of the loans are passed on to consumers. This leads to inflation as a consequence of the rise in the prices of goods and services. The problem is compounded where the Central Bank has to issue some more Treasury Bills to control the inflation that rises from the high interest rates. Operations cost, credit and liquidity risk, and return on assets had a positive linear relationship with interest rate spread. The study concluded that bank-specific factors (credit risk, liquidity risk, return on assets and operating costs) significantly influenced interest rate spread. The interest rate spread was sensitive to GDP and inflationary pressures. It is recommended that CBK should apply stringent regulations on interest rates charged by banks to make them more receptive to monetary policies. Information asymmetry to be reduced to lower banking risk, thus result in lower spread. The study recommends that further studies be done on the effect of interest rate spread on loan delinquency and performance of commercial banks.