The Effects of Income Diversification and Non –Performing Assets on Interest Spread among the Kenyan Commercial Banks.

Abstract

Banking institutions plays a major role in a country’s and global economy. An efficient financial intermediation has a direct impact on effectiveness of investable resource mobilization, and thus, economic development. A major indicator of efficiency in banking sector is the interest rate spread which indicates the level of financial sector’s development. Therefore, a major goal in financial sector deepening and financial liberalization is the narrowing down of interest spread.  In Kenya various structural changes intended to lower interest rate spread were initiated by the Central Bank of Kenya (CBK) since interest rate liberalization in early 1990s, but as documented in various Monetary Policy Statement issues and acknowledged by the Industry players and policy makers, interest rate spread remained high. But commercial banks have undergone a lot of changes characterized by new business models anchored on enhanced technologies and innovativeness; income diversification and others, in order to help them in reducing interest rate spread. Therefore this study sought to establish the effect of income diversification and non-performing assets on interest rate spread among Kenyan commercial banks. While few studies had been conducted in this subject, none had captured the post economic crisis period in a broad way. Further, income diversifications, a product of commercial bank evolution in the period under study, received little attention. The study used quarterly bank-specific, industry specific and macroeconomic data between 2004 and 2014. Random effect regression analysis was used to meet the objective.  Regression results indicated a 0.11 percent fall in spread following a 1 percent increase in the proportion of non-interest income to total income. No significant relationship was observed between spread and non-performing assets. But market concentration and operation cost had significant positive relationship. On the other hand, increased illiquidity in commercial banks reduced spread. The study recommends focus on operational efficiency, income diversification, market competition, reduced return’s appetite and scaled credit information sharing.

Keywords: Income Diversification; Nonperforming Assets; Interest rate spread; Banking Institution.