The Effect Of Interest Rates Spread On Lending Capacity Of Bank A Case Study Of Barcla Ys Bank Of Kenya

ABSTRACf

A key indicator of financial performance and efficiency is the spread between the lending

and deposit rate. If this spread is large, it works as an impediment to the expansion and

development of financial intermediation. This is because it discourages potential savers

due to low returns on deposits and thus limits fmancing for potential borrowers. This has

the economy wide effect of reducing feasible investment opportunities and thus limiting

future growth potential. It has been observed that large spreads occur in taxation or

repression, lack of competitive financial banking sector and macroeconomic instability.

That is risks in the financial sector are high. Financial reforms and liberalization should

improve efficiency in the intermediation process. This implies that the spread will decline

over time as liberalization is accomplished and financial sector develops. But in Kenya

financial liberalization seems to have led to a widening interest rate spread. The main

factors that propel this are distortions in the loans market, institutional and policy factors

impact on transaction costs compound the effects of risks and uncertainty in the market

thus worsening the spread. To narrow the interest spread it is important to maintain a

stable macroeconomic environment and thus reduce credit risks. There is also a need to

minimize implicit taxes like reserve requirement and cash ratios accompanied by fiscal

discipline to reduce the demand for financing budget deficit with low cost funds. Banks

should perform more screening functions than simply investing in treasury bills to

enhance economic growth and invest in information capital to reduce the moral hazard

and adverse selection problems. By enhancing competitiveness in the Treasury bill market and promoting diversification of financial assets for investors banks will have to compete for public funds. The result of this will be to squeeze the spread from increasing deposit rate. Above all strengthening the institutional base is important in enhancing enforceability of contract