Exploring the determinants of interest rate spreads in the Uganda banking system

Interest spreads in Uganda have been persistently high over the last two decades. This paper aims to complement the literature by investigating the determinants of interest rate spreads in Uganda, following the period after the adoption of Inflation Targeting, using three different approaches:

• First, a cross country comparison with regional peers;
• Second, a decomposition of interest rates spreads in Uganda;
• Third, a panel data analysis using system generalized method of moments (GMM).

A consistent result from each of our analytical approaches is that overhead costs are positively and significantly related with bank spreads. Other important variables in explaining bank spreads include the return on assets, Herfindahl index, non-performing loans, economic growth, the exchange rate and the interest rate.

The results have important implications for economic policy: singling out the need for a reduction in overhead costs which needs to complemented with increased bank competition.

Other policy measures that could facilitate a lowering of spreads include: a reduction in domestic government borrowing and a lowering of the sector’s non-performing loans through better credit risk assessment.