Publication - Working Paper
Publication - Policy Brief
In spite of the various reforms and policy initiatives in the Ghanaian banking industry aimed at improving efficiency in the industry in order to curtail interest rates, banks continue to exhibit high interest rate spreads. This high spread suggests that banks are operating inefficiently and this has serious implications for the functioning of the private sector and the economy at large as businesses have to borrow at a significantly higher cost. Previous empirical studies have tended to investigate how bank-specific financial factors affect the bank interest rate spreads. What is lacking in the extant literature is whether the agency problem provides any explanation to the bank interest rate spreads. Departing from previous studies, this current study investigates the extent to which the principal-agent conflict contributes to interest rate spreads in Ghana. The study specifically examines the relationship between interest rate spreads in the Ghanaian banking industry and variables that reflect convergence/divergence between managerial goals and corporate goals of which the key variables are executive compensation and bank ownership structure.
Using data covering the period, 1999-2011, this study employed a panel regression to examine how agency factors (bank compensation systems and ownership structure) affect interest rate spreads in Ghana. The findings of the study suggest that corporate governance mechanisms play a role in the way interest rate spreads are set in Ghana. If managers believe that they can extract excess rents from the bank (in terms of directors’ fees and employee emoluments) then they tend to charge a higher net interest margin. Board composition is positively related to net interest margin. This result may be explained by “board capture” which has the tendency of weakening the monitoring role of the board in checking opportunistic behaviour of management. Further, the findings suggest that, the ownership structure of banks is important in influencing the observed interest rate spread of banks. Publicly listed banks exhibit a significantly higher spread compared to non-listed banks. This suggests that publicly listed firms may be under pressure in the short-term to show high profits and appreciating share value. Banks with a more concentrated ownership exhibit a lower spread since shareholders in such banks are better able to monitor the activities of their managers.
With regards to bank level factors, we find that inefficient banks show a lower spread. This tends to suggest that such banks are not able to pass on their full costs to their clients. The results show that older banks operate on a lower spread to protect their reputation with their clients and regulators. Industry and macroeconomic level indicators are also found to play a key role in influencing interest rate spreads in Ghana. Lower level of competition is associated with lower interest spreads. Macroeconomic stability is important as the findings suggest that reducing the level of inflation may aid in bringing down the spread. There are some policy implications emerging from the study. The key policy implication is that improved corporate governance of banks will have favorable effects on the interest rate spreads. Improved corporate governance will provide for a more transparent method of setting executive compensation and perks. The design of executive compensation models that are more incentive compatible should engage the attention of bank regulators and boards of directors.