Determinants of interest rate spread among commercial banks of Kenya

Abstract

The increase in interest spread discourages savings and investments on one hand, and raises concerns on the effectiveness of bank lending channel of monetary policy on the other. An increase in the interest spread implies that either the depositor or the borrower or both stand to lose. This study aimed at establishing the determinants of interest rate spread among commercial banks in Kenya. Among the many determinants of interest rate spread, this study hypothesised that inflation, operating costs, market structure, ownership structure and business risks affect the behavior of commercial banks in Kenya while setting interest rate. Other studies done in this area have mainly concentrated on the impact of interest rate spread on investment opportunities while this study focused on the determinants or the raisen de’etre of high interest rate spread in Kenya. The study used both secondary and primary data. The target population of this study was all employees at management and supervisory levels of the 44 commercial banks licensed by the Central Bank of Kenya and were in operation as on 31st December 2012. The total population as at 31st December 2012 was 13924 units. The sample size of 384 respondents was drawn from the population using a formula recommended by Mugenda and Mugenda when the population is over 10000 units. This study used stratified random sampling and simple random sampling. The strata were those of management and supervisory cadre. Questionnaires were used to collect primary data while secondary and quantitative data was collected from the statistical abstracts and bulletins of both the Central Bank of Kenya and the Kenya National Bureau of statistics. Cronhbach’s Alpha reliabity test and factor analysis were carried out in order to test the goodness of the research instrument. Multiple linear regression was used to analyze data to produce descriptive and inferential statistics. Content analysis was used to operationalize qualitative data and eventually was analyzed using statistical methods for inferential conclusions. F-test was used to test the significance of the overall model while significance of each specific variable was tested using T- test. Based on the research findings, it can be concluded that ownership structure, market structure and business risks play significant role in explaining interest rate spread. The study recommends that the government and policy makers should implement sustainable political and macroeconomic environment to boost investors’ confidence in the banking sector which would go a long way in reducing interest rate spread. This study did not include all determinants of IRS and a further study is recommended to include other factors such as effects of information and communication technology on interest rate spread.