Abstract
This paper examined how the relationship between market power and bank spread is affected by product diversification. Two different indicators were used for bank spread namely: interest rate spread and gross margin. We used bank level data from 13 commercial banks sampled from a total of 40 banks on the basis of availability of complete data for the period 2009-2018 through purposive sampling. The data was captured in panel data form and analysed using SPSS and STATA software to obtain descriptive, correlation and regression analyses. The main findings are that in the presence of a diversified portfolio, the impact of market power on bank spreads turns negative. Kenya’s banking sector has a diversified loan and deposits portfolio. Income streams still have a low diversification level with most incomes being linked to the lending activities of the banks.The study recommends further diversification of revenue streams and effective deployment of skilled staff to the credit function for effective management of the loan book to avoid high default incidence as a strategy for reducing bank spreads Keywords: Bank spread, product diversification, market power DOI: 10.7176/JESD/12-14-11 Publication date: July 31 st 2021
Highlights
Market Power refers to the ability of a firm to raise the prices of goods and services thereby increasing its profitability
This is because banks with comparatively high market share have market power and can exercise this power to act as price setters earning higher margins in the process
Reharjo et al (2014) found this to be true in his study of interest margin determinants in Indonesia where, using the loans market share, he found market share to be positively associated with interest margins
Summary
Market Power refers to the ability of a firm to raise the prices of goods and services thereby increasing its profitability. Earlier on Maudos and Guevara (2004) noted the co-existence of a situation of increasing market power and reducing interest rate spread contrary to theory This situation, according to Valverde and Fernández (2007)) can partly be explained by the existence of diversification as diversified banks are able to engage in pricing competition on one product. Diversification increases market power and at the same time diversified banks may use their market power to engage rivals in price competition by reducing interest margins while compensating the lost incomes through non-traditional activities. In a non-competitive environment, a high market share is positively related to interest margins for all the three ratios above This current study will use the ratio of individual bank loans to total commercial banks’ loans to measure market share (Ugur & Erkus , 2010; Raharjo et al, 2014).
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