Effect Of Bank Characteristics On Interest Rate Spread Of Commercial Banks In Kenya

Abstract

A well-functioning financial system with optimal interest rate spreads in commercial banks is crucial for economic growth and development. Commercial banks play a key role in mobilizing savings, allocating capital, and financing investments, which are all critical to achieving sustainable economic growth. Optimal interest rate spread ensure that banks have sufficient margins to cover their operating costs and risks, while also providing affordable credit to borrowers. This, in turn, encourage investment and entrepreneurship, leading to increased economic activity and employment. The objective of this research is to examine the effect of bank characteristics on the interest rate spread of commercial banks in Kenya. The key objectives of this research are to assess the impact of deposit levels, liquidity, asset quality, and bank size on the interest rate spread across commercial banks operating in Kenya. This research was grounded on the theoretical frameworks of the liquidity preference theory, Fisher theory, and financial intermediation theory. The research used a descriptive research design. The selected sample consisted of 42 commercial banks located in Kenya. Due to the limited size of the target group, the research included the whole population. The research used secondary panel data spanning the years 2018 to 2022. The study included the use of descriptive statistics, including various metrics such as frequency distributions, percentages, variances, measures of dispersion (specifically standard deviation), and mean. The method of regression analysis was used to conduct inferential statistics. The study used a Fixed Effects model to explore how bank characteristics influence Interest Rate Spread in commercial banks in Kenya. Deposit Levels increased Interest Rate Spread by 0.041358 units (p-value 0.000), Liquidity by 0.022596 units (p-value 0.000), Asset Quality decreased it by -0.04441 units (p-value 0.000), and Bank Size increased it by 0.004325 units (p value 0.000). All these factors were statistically significant at a 5% level, leading to the rejection of all null hypotheses. This indicates that higher deposit levels and liquidity slightly increase interest rate spread, better asset quality decreases it, and larger bank size is associated with a higher spread. The study concluded that in Kenyan commercial banks, four factors significantly influence the interest rate spread: deposit levels, liquidity, asset quality, and bank size. Higher deposit levels and liquidity can increase the spread, while better asset quality also positively impacts it. Larger bank size is associated with a wider interest rate spread. Recommendations include increasing deposit levels, maintaining high liquidity, improving asset quality, and for smaller banks, considering growth and expansion.