The relationship between interest rate spread and profitability of commercial banks in Kenya

This research project sought out to determine the relationship between \ninterest rate spread and profitability of commercial banks in Kenya. \nTo achieve this objective, three regression models were developed using \ninterest rates and profitability data for the period between 1996 and 2002. \nInterest Rate Spread was measured by the difference between lending and \ndeposit rates. The profitability indicators used were the Return on Total \nAssets (ROTA), Return on Equity (ROE) and the Net Interest Margin \n(NIM). \nThe study found out that interest rate spread contributes less than 50% \ntowards the profitability of commercial banks in Kenya. Interest rate spread \nexplains 38.4% of profitability as measured by NIM, 40.1 % when measured \nby ROTA and 43.3% when measured by ROE. \nVariations in interest rate spread explain 14.7% of the total variations in the \nprofitability of commercial banks when measured by NIM, 16.1 % when \nmeasured by ROTA and 18.7% when measured by ROE. \nFor peer group I, interest rate spread contributes less than 50% towards the \nprofitability of commercial banks in Kenya when measured using ROT A \nand ROE while it contributes 77.9% when measured using NIM. \nFor peer group 2, interest rate spread contributes less than 50% towards the \nprofitability of commercial banks in Kenya when measured using NIM \nwhile it contributes to more than 50% when measured using ROTA and \nROE. \nFor peer group 3, interest rate spread contributes less than 500/0 towards the \nprofitability of commercial banks in Kenya when measured using NIM and \nROTA while it contributes to slightly more than 50% when measured using \nROE. \nFor peer group 4, interest rate spread contributes less than 50% towards the \nprofitability of commercial banks in Kenya when measured using ROT A \nand ROE while it contributes to more than 50% when measured using NIM. \nThis implies that commercial banks will no longer rely on interest rate \nspread as their main source of profitability. Commercial banks will in the \nlong run rely less and less on their traditional intermediation role and instead \nmove towards other innovative ways of raising fee income.