Interest rate spread in Uganda - An empirical investigation

Abstract

Interest rate spread is one of the measures of financial sector efficiency. With an end to financial repression on the one hand and interest rate liberalisation on the other, the spread is expected to narrow down. In Uganda Interest rates were fully liberalised by July 1994 with a target to improve financial sector efficiency and a move to indirect monetary control. However, the persistence of high Interest rate spread has been a disquieting outcome of the reforms. This scenario of the spread affects the economy in such a way that the low deposit rate discourages savings, where as on the other hand the high lending rate discourages borrowing and subsequently the level of investment. The study shows that factors such as; the high lending rate, the low deposit rate, the large size of the non-performing loans, the costs of operating the financial institutions, taxation effects, institutional and policy factors, and dis-equilibrium in the loans market among others contribute to the apparently wide interest rate margins. And finally the findings indicate that interest rate spread in Uganda for the period 1995-2000 was a short run phenomenon. If the spread is to be narrowed down, there is a critical need to achieve macroeconomic stability and to reduce information asymmetry. This is expected to reduce the levels of risk in the financial sector. Additionally increased competition in the banking sector and minimizing the role of government in the running of the economy are crucial to this cause.