Effects of interest rate spreads on financial performance of mortgage banks in Kenya

Abstract

It is widely believed that fluctuations of market interest rates exert significant influence on the activities of commercial banks. The effect of interest rate spread changes on banks’ profitability is shown to be asymmetric with the effect originating from lending rates being greater than those of deposit rates. The objective of this study was to determine the relationship between interest rates spread and the performance of mortgage banks in Kenya. This was a census study of all registered 43 commercial banks in Kenya and relied heavily on documentary secondary data for 5 year study period (2009-2013). The study found that interest rates spreads are higher for larger banks than for medium and small banks. On average, small banks have lower spreads. This could possibly be due to the fact that small and low-capitalized banks find it relatively difficult to raise funds and have to increase their deposit rates to attract funds and compensate for the perception that they are more risky relative to large, more liquid, well capitalized banks that are perceived to be ‘too-big-to-fail’. If the higher spreads are merely interpreted as an indicator of inefficiency, one can easily be tempted to conclude from the positive relationship between bank size and interest rate spreads that big banks are less efficient, which may not necessarily be the case. 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. The study concludes that there is a positive linear relationship between interest rate spread and financial performance measured as return on assets (ROA) and return on equity (ROE). There are also statistically significant positive relationships between market power, liquidity, operating efficiency and return on assets (ROA) and return on equity (ROE). The study recommends that a study should be replicated in other commercial banks and microfinance institutions across East Africa and beyond to validate such results.