Wide interest rate spreads, any hope for small economies? A look at Malawi

Abstract

The aim of this paper is to study the trend of interest rate spread in Malawi and establish if any association exists between economic growth (measured by real GDP) and the spreads. The study adds to the existing literature in that it analyses in detail the factors that cause wider interest rate spreads in Malawi and other developing countries, and provides suggestions on alternatives to adopt in order to narrow the spreads. The study further establishes a link between a country’s economic growth and its real interest rate spread as provided by the commercial banks in Malawi. Using a correlation and regression analysis on data ranging from 2006 to 2014 derived from a sample of Malawian banks, the results suggest that in small economies, the banking sector’s over reliance on interest income is significantly correlated with wide interest rate spreads and therefore if commercial banks come up with other revenue generation avenues, other than leaning wholly on interest revenue, the interest rate spread can be narrowed; and that the wider spreads so far recorded have a reasonable contribution to the malfunctioning economy. The study finds a strong relationship between inflation rate and interest rate spreads but fails to establish a strong and significant relationship between interest rate spread and GDP growth.

Key words: interest rate spread, inflation, banking sector, liquidity reserve requirement, GDP.