The Effect of Interest Rate Spread on Financial Performance of Deposit Taking Micro-finance Banks in Kenya

Abstract

MFIs over the past have primarily focused on micro lending activity and ignored savings deposits, therefore deposit taking microfinance bank (DTMB) business can be called a venture still in its determining stages. The Microfinance Act which became operational on 2nd May 2008 saw most of the micro-finance institutions apply for licenses to allow them to take deposits in Kenya after year 2009. DTMBs have demonstrated a good outreach especially in the rural areas with improved financial performance and have managed to reach close to a third of clients who were previously excluded from financial access. This calls for special attention by government towards this business. DTMBs need to be effective, efficient and competitive in their operations. Interest rates spread, as sensitive variable influencing financial performance, ought to be adequately harmonized so that savers have the assurance that they are getting the best returns on their savings and that borrowers are getting rates appropriate to their investments. The main objective of the study was to establish the effect of interest rate spread and on the financial performance of DTMBs in Kenya. Additionally, the researcher wanted to ascertain the influence of other industry specific variables and macro-economic environment on DTMBs financial performance. The research study utilized descriptive research design and embraced systematic random sampling technique on selecting the four DTMBs in Kenya out of the nine existing in the country. Secondary data were analyzed and presented inform of tables and figures to provide a clear picture of how interest rates spread contribute in the success or failure of the DTMB business and to show the various characteristics and relationships among the variables in consideration. Findings showed that interest rate spread is statistically significant at 95% and 99% significant level with a negative correlation thus as IRS increases the financial performance of DTMBs decreases. The other controlling market (industry) specific and macro-economic environment variables, that is, leverage, non performing loans, liquidity ratio and GDP per capita annual growth in % ratio showed a statistically significant positive correlation hence play a major role in positively influencing the performance of micro-banking industry and are therefore important for DTMB business to operate as a going-concern in the foreseeable future. It is evident from the research findings that the interest rate spread provided sufficient margins for microfinance banks to continue operating in the market. In conclusion, the study found out that interest rates spread negatively affect the financial performance of DTMBs in Kenya. The researcher therefore, recommended to the microfinance banks’ management to be both proactive and reactive in harmonizing interest rates spread in order to cushion their institutions from any financial shocks that could be experienced in the micro-banking industry in Kenya. Lastly, it is of great importance for the DTMBs to pay great attention to credit risk when evaluating customers’ loan proposals due to the fact that a large chunk of banks’ revenue accrues from loans from which interest income is derived.