Determinants of Interest Rate Spreads In Uganda’s Commercial Banking Sector: A Panel Data Analysis

Abstract

Uganda’s interest rate spreads have persistently remained high despite the financial liberalisation undertaken in the 1990s. Using data for 24 banks, we assess the determinants of interest rate spreads in Uganda’s commercial banking sector for the period 2005-2015. Results show that, among the bank-specific factors, interest rate spreads increase with increase in credit risk, liquidity risk, and capital adequacy ratio. Contrary to most studies and a priori expectations, non-interest income is shown to be positively related to bank spreads. Bank size is shown to be negatively related to interest rate spreads. For industry-specific factors, foreign bank participation in loans markets is associated with higher spreads. For macroeconomic factors, high inflation rates are shown to translate into high spreads, whilst high real GDP growth rates and broad money supply are associated with lower spreads. Contrary to theory and most literature, exchange rate volatility is associated with lower bank spreads. Going forward, banks and government should devise mechanisms to encourage loan repayment, and banks should be encouraged to reduce on holding excess liquid assets. At a macro-level, the Bank of Uganda should maintain its stance on curbing inflation. Economic growth and financial development should as well be encouraged.

Keywords: interest rate spreads; dynamic panel; Uganda’s commercial banking sector JEL Classifications: C23; E43; E44; G21; L11