JEFMS Journal

Google Scholar

Article Pdf

---

ABSTRACT:

The determination of interest rate spread in commercial banks is influenced by various macroeconomic variables, market microstructure features and the policy environment. However, studies on factors that contribute to the interest rate spreads among commercial banks in Kenya have produced mixed results that calls for further research. This study aimed to assess the determinants of interest rate spread in commercial banks in Kenya. Specifically, the study sought to establish the effect of inflation rate, domestic borrowing, credit risk and exchange rate risk on the interest rate spreads among commercial banks in Kenya. The study was anchored on fisher hypothesis, classical theory of interest and loanable fund theories. Explanatory research design was adopted to establish the causal relationship between the study’s variables. Secondary data of the study for the period between 1970 -2022 was extracted from annual financial statements of commercial banks targeted by the study and Central bank of Kenya annual reports. Data was analyzed through descriptive and inferential statistics. The study adopted the regression model to obtain results. Based on the regression results, the study found that domestic borrowing had a significant positive effect on interest rate spreads among commercial banks in Kenya. Additionally, the study found that inflation rate, credit risk and exchange rate risk had a significant positive effect on interest rate spreads among commercial banks in Kenya. The study concluded that macroeconomic variables such as inflation rate, domestic borrowing, credit risk and exchange rate risks are key determinants of interest rate spread among commercial banks in Kenya. The study made the following recommendations to regulators and policy makers. First, ensure that the central bank's monetary policy actions effectively influence interest rates throughout the banking system and also Implement mechanisms to improve the transmission of changes in the central bank's policy rates to commercial banks' lending and deposit rates. Secondly, establish a framework for monitoring key macroeconomic indicators such as inflation, economic growth, exchange rates, and fiscal policies to identify potential factors impacting interest rate spreads and use the monitoring results to formulate timely and appropriate policy responses. The study recommends that future studies should conduct studies across different countries which could provide a more comprehensive understanding of the subject matter.

KEYWORDS:

Interest rate spread, inflation rate, credit risk, exchange rate risk

REFERENCES:

1) Aikoh, K. J. (2016). Determinants of interest rate spread in commercial banks: A case study of selected local and foreign banks in Tanzania (Doctoral dissertation, Mzumbe University).

2) Al Shubiri, F. N., & Jamil, S. A. (2017). Assessing the determinants of interest rate spread of commercial banks in Oman: an empirical investigation. European Research Studies, 20(2), 90.

3) Amewu, G., Junior, P. O., & Amenyitor, E. A. (2022). Co-movement between equity index and exchange rate: fresh evidence from Covid-19 era. Scientific African, 16, e01146.

4) Berko, D., Hammond, P., & Amissah, E. (2022). The Effect of Interest Rate Spread on Economic Growth: Ghana’s Perspective. International Journal of Business and Management Review, 10(2), 1-23.

5) Bhattarai, Y. R. (2015). Determinants of lending interest rates of Nepalese Commercial banks. Economic Journal of Development Issues, 39-59.

6) Buryk, Z., Bashtannyk, V., & Ragimov, F. (2019). Economic growth: macroeconomic effects of Public Borrowings at the global level. Problems and perspectives in management, 17(3), 169.

7) Cohen, L., Manion, L., & Morrison, K. (2018). Research methods in education. routledge.

8) Corsetti, G., Keuster, K., Müller, G. J., & Schmidt, S. (2021). The exchange rate insulation puzzle.

9) Damane, M. (2022). Investigating the determinants of commercial bank interest rate spreads in Lesotho: Evidence from autoregressive distributed lag (ARDL) and non‐linear ARDL approaches. International Journal of Finance & Economics, 27(4), 4256-4278.

10) Dane, F. C. (2017). Research methods. Thomson Brooks/Cole Publishing Co.

11) Didia, D., & Ayokunle, P. (2020). External debt, domestic debt and economic growth: The case of Nigeria. Advances in Economics and Business, 8(2), 85-94.

12) Ekinci, R., & Poyraz, G. (2019). The effect of credit risk on financial performance of deposit banks in Turkey. Procedia Computer Science, 158, 979-987.

13) Folawewo, A. O., & Tennant, D. (2018, July). Determinants of interest rate spreads in Sub-Saharan African countries: A dynamic panel analysis. In A paper prepared for the 13th Annual African Econometrics Society Conference (pp. 9-11).

14) Gitahi, N. S. (2018). Effect of workplace environment on the performance of commercial banks employees in Nakuru town (Doctoral dissertation, Kabarak University).

15) Gitau, G. N. (2017). Effects of interest rate spreads on financial performance of mortgage banks in Kenya (Doctoral dissertation, University of Nairobi).

16) Githinji, E. (2016). Determinants of financial stability among commercial banks in Kenya (Doctoral dissertation, United States International University-Africa).

17) Goh, P. C. (2018). Intellectual capital performance of commercial banks in Malaysia. Journal of intellectual capital.

18) Hassan, M. K., Khan, A., & Paltrinieri, A. (2019). Liquidity risk, credit risk and stability in Islamic and conventional banks. Research in International Business and Finance, 48, 17-31.

19) He, Q., Liu, J., & Zhang, C. (2021). Exchange rate exposure and its determinants in China. China Economic Review, 65, 101579.

20) Ibrahim, A. K., & Khan, S. M. (2019). Domestic debt and economic growth in Nigeria: An ARDL Bounds test approach. Economics and Business, 33(1), 50-68.

21) Itimu, S. M., & Abdul, F. (2018). Determinants of average lending rates among selected commercial banks in Kenya. International Academic Journal of Economics and Finance, 3(1), 142-158.

22) Jha, S., & Hui, X. (2017). A comparison of financial performance of commercial banks: A case study of Nepal. African Journal of Business Management, 6(25), 7601-7611.

23) Kalsoom, A., Khurshid, M. K., & Campus, F. (2016). A Review of Impact of Interest Rate Spread on Profitability. Research Journal of Finance and Accounting, 7(11), 23-26.

24) Kamunge, E. M. (2018). The Effect of Interest Rate Spread On The Level Of Non Performing Loans Of Commercial banks In Kenya (Doctoral dissertation, University of Nairobi).

25) Kinyuru, F. G. (2017). Determinants of Lending Rate of Commercial banks in Kenya (Doctoral dissertation, University of Nairobi).

26) Kipngetich, K. M. (2016). The relationship between interest rates and financial performance of commercial banks in Kenya (Doctoral dissertation, University of Nairobi).

27) Kiptui, M. C. (2020). Determinants of Interest Rate Spread: Some Empirical Evidence from Kenya's Banking Sector. International Business Research, 7(11), 94.

28) Kithinji, A. M. (2017). Credit risk management and profitability of commercial banks in Kenya.

29) Kola, F., Gjipali, A., & Sula, E. (2019). Commercial bank performance and credit risk in Albania. Journal of Central Banking Theory and Practice, 8(3), 161-177.

30) Kukk, M., & Levenko, N. (2022). Interest rate spreads in Estonia: different stories for different types of loan. Eesti Pank.

31) Leonard, L., Chepkulei, B., & Rop, B. K. (2018). Effects of Interest Rate Spread on the Performance of Banking Industry in Kenya. Jomo Kenyatta University of Agriculture and Technology.

32) Liu, T. Y., & Lee, C. C. (2022). Exchange rate fluctuations and interest rate policy. International Journal of Finance & Economics, 27(3), 3531-3549.

33) Maigua, C., & Mouni, G. (2016). Influence of interest rates determinants on the performance of commercial banks in Kenya. International journal of academic research in accounting, finance and management sciences, 6(2), 121-133.

34) Maina, M. W. (2019). Determinants of interest rate spread among commercial banks of Kenya (Doctoral dissertation).

35) Misati, R. N., Nyamongo, E. M., & Kamau, A. W. (2016). Interest rate pass‐through in Kenya. International Journal of Development Issues.

36) Mose, N., & Kaboro, J. (2019). Does inflation rate convergence spur exchange rate volatility? Empirical evidence from sub-Saharan Africa. Asian Journal of Economic Modeling, 7(2), 95-109.

37) Mukhanyi, M. (2016). Determinants of lending behaviour of commercial banks in Kenya (Doctoral dissertation, University of Nairobi).

38) Musarat, M. A., Alaloul, W. S., & Liew, M. S. (2021). Impact of inflation rate on construction projects budget: A review. Ain Shams Engineering Journal, 12(1), 407-414.

39) Ng’ang’a, A. K. (2017). The impact of interest rate capping on the financial performance of commercial banks in Kenya. Unpublished MBA Project, University of Nairobi.

40) Ng’etich Joseph Collins, K. W. (2015). The effects of interest rate spread on the level of non-performing assets: A case of commercial banks in Kenya. International Journal of Business and Public Management (ISSN: 2223-6244) Vol, 1(1), 58-65.

41) Ngugi, R. W. (2017). An empirical analysis of interest rate spread in Kenya.

42) Njeri, B. K., Ombui, K., & Kagiri, A. (2018). Determinants of interest rate spread of commercial banks in Kenya. International journal of science and research, 6(5), 2319-7064.

43) Njoroge, L., & Chogii, C. D. (2017). Determinants of interest rate spread among commercial banks in Kenya. International Journal of Finance, 2(5), 75-92.

44) Otieno, D. A., Ngugi, R. W., & Muriu, P. W. (2019). The impact of inflation rate on stock market returns: evidence from Kenya. Journal of Economics and Finance, 43, 73-90.

45) Poudel, R. P. S. (2012). The impact of credit risk management on financial performance of commercial banks in Nepal. International Journal of arts and commerce, 1(5), 9-15.

46) Sangmi, M. U. D., & Nazir, T. (2018). Analyzing financial performance of commercial banks in India: Application of CAMEL model. Pakistan Journal of Commerce and Social Sciences (PJCSS), 4(1), 40-55.

47) Sumon, S. M., Ahmed, R., Fahria, N., & Faruk, O. (2022). Domestic Borrowing Influence on Financial Development-Empirical study for Bangladesh. Innovation in Economy & Policy Research, 35-45.

48) Tarus, D. K., Chekol, Y. B., & Mutwol, M. (2018). Determinants of net interest margins of commercial banks in Kenya: A panel study. Procedia Economics and Finance, 2, 199-208.

49) Walliman, N. (2017). Research methods: The basics. Routledge.

50) Were, M., & Wambua, J. (2016). Assessing the determinants of interest rate spread of commercial banks in Kenya: An empirical investigation. Kenya Bankers Association.

51) Williams, C. (2019). Research methods. Journal of Business & Economics Research (JBER), 5(3).