Interest Rate Spread in Ghana’s Banking Sector: 2000 – 2014

Abstract

(ProQuest: ... denotes formulae omitted.)1.IntroductionBank interest rate spread reflects the difference between ex-ante lending and deposit rates. It generally measures bank intermediation efficiency. Higher interest rate spreads indicate high intermediation cost and existence of asymmetric information problem which leads to agency cost for banks and reduced efficiency. Low interest rate spread is desirable for most economies because it promotes economic growth by providing higher expected returns for savers, increasing loanable funds and lowers borrowing cost for investors (Ndung'u & Ngugi, 2000).However, the banking sector in many developing countries is characterized by persistently high interest rate spreads thereby depicting the poor financial intermediation in these countries. Evidence shows that interest rate spreads in subSaharan Africa, Latin America and the Caribbean are wider than in Organization for Economic Cooperation and Development (OECD) countries (Randall, 1998; Brock & Rojas-Suarez, 2000).In Ghana, interest rate spread has become a debatable issue in recent times as the financial market liberalization has failed to significantly reduce the spread. Since the beginning of the second phase of the Financial Sector Adjustment Programme (FINSAP II) in 1994, the banking sector activities have improved and witnessed growth. This brought in its wake the emergence of new banks, increasing the number from 17 in 2002 to 27 by 2014. There has been a reduction in bank reserve requirements and some level of competition in the industry resulting in improved service delivery to clients.The observed downward rigidity in interest rate spread in Ghana may be explained by regulated entry and exit of firms in the banking industry, moral hazard problems, high operational costs, macroeconomic instability and high cost of capital. Many studies have shown these factors as major causes of high interest rate spreads in African countries in general (Chirwa & Mlachila 2004; Beck & Heiku, 2009).Furthermore, the banking sector of Ghana is characterized by high transaction costs associated with loan recovery due to the absence of reliable street address system to locate clients, high cost of verifying business and biographical information of loan applicants, absence of reliable credit records system to track and assess loan balances that applicants may be servicing with other banks at the time they put in applications for new loans. As a result of these, loan default rates have remained relatively high in Ghana, unlike in developed countries.The motivation of this study is therefore to try and identify what really influences the interest rate spread in Ghana and provide solution to reducing the wide spread in the interest rates.Ghana's interest rate spread is relatively high compared with some of the other sub-Sahara African countries. It averaged 15% between 2005 and 2010 which is more than that of Gabon (13%), Kenya (10.1%), Nigeria (5.5%), Uganda (12.9%) and Tanzania (9.7%). Therefore, the concern of the business community and policymakers has to do with the persistently high level and non-competitive nature of interest rate spreads in Ghana. This is because; the non-competitive nature of the spread could be detrimental to sustaining high economic growth.The problem and, indeed, one of the main focus of of this study, is that despite the financial sector reforms over a decade ago, interest rates spread still remains persistently wide. So, why is this the case? To what extent do individual bank factors, banking industry factors or macroeconomic factors influence the spread? What policy options are available to reduce the spread and make the sector more efficient? Answers to these questions will help understand the nature of interest rate spread in Ghana.The main objective of this study is therefore, to examine the factors that influence the interest rate spread in Ghana from year 2000 to 2010 which essentially covers the era of post-liberalization of the financial sector. …