The Effect of Inflation Rate on Interest Rate Spread in Commercial Banks in Kenya

Abstract

T The objective of the study was to examine the determinants of commercial bank interest rate spreads in Kenya. The research was carried out among the 42 commercial banks in Kenya. This research was necessitated by the fact that interest rate spreads are relatively high even after the liberalization of the interest rates in July 1990.The aim of this study was to investigate the levels and trends in interest rate spreads, to document the key macroeconomic and market determinants of interest rate spreads and to provide policy options that would help to narrow the interest rate spreads so as to enhance the efficiency of the Banking Sector and hence economic growth and development of Kenya. In particular, the study investigated the effects of inflation rate, cash requirement reserve and the central bank discount rate on interest rate spreads. Since the number of banks is not so large, all the 42 commercial banks were targeted in the study. Secondary data was used in this study which was collected from annual reports (monthly) of the 42 commercial banks for the 8 year period between 2007 and 2014. The study found that the model accounted for 66.59% of the variance in interest rate spread of the commercial banks R2= 0.6659. The Fstatistic of 60.4579 was significant at 5% level of significance, p = 1.37E-21. This shows that the model was fit to explain the effect of inflation rate on the interest rate spread. The results showed that inflation rate had a weak positive effect on interest rate spread of the commercial banks which was insignificant at 5% significance level while cash requirement reserve and discount rate had positive effects which were significant at 5% significance level. The study therefore concludes that inflation rate does but insignificantly influence the interest rate spread of the commercial banks. The study recommends that other factors that influence the interest rates of commercial banks be used in order to ensure that commercial banks set optimal interest rate spreads.