Product Diversification and Its Effects on Bank Spread:The Case of Commercial Banks in Kenya

Abstract

This study aimed at evaluating the effect of product diversification on bank spreads. Applying Valverde and  Fernández's (2007) extended model of interest spread determinants, the study uses secondary data  from commercial banks in Kenya covering the period 2009 to 2018. The data, organized in panel form was analysed using correlation and regression with the help of the PCSE estimator to ensure robustness of results. On the overall, the study found that income diversification and demand deposits ratio have a positive relationship while loans diversification has a negative impact on banks spreads. The results were significant and in similar directions for both spread indicators. These findings lead us to conclude and recommend that banks draw the benefit of risk mitigation by diversifying into various sectors of the economy and indeed this has the result of reducing bank spread. There is therefore need to encourage banks to diversify more and indeed there is an opportunity to do so as the penetration in a good number of sectors was found to still be quite low. Risk-based lending and up skilling of staff in all sectors will go a long way in helping in this endeavour. Income diversification is not yet achieved and commissions and fees are still heavily tied to the making of loans through charging of negotiation fees. Banks need to be encouraged to venture more into non-funds based income streams like insurance, trade facilitation and investment advisory services. With the help of technology, agency networks and general awareness of the population about formal banking, commercial banks have been able to mobilize a lot of demand deposits. They now need to transfer part of the benefits of this to the customer by way of interest earning deposit products for clients with surplus and reduced lending rates for borrowing customers.

Keywords: Product Diversification, Bank spread

DOI: 10.7176/EJBM/13-10-10

Publication date:May 31^st 2021