Credit Risk and Interest Rate Spreads in Banking: A case of Uganda

Abstract

The study investigates the effect of credit risk on interest rate spreads in Uganda for the period 1981-2008, while controlling for macroeconomic factors (Inflation, Liquidity, T-bill rate) and client-bank relationship. This was accomplished using a modern econometric technique that was adopted and used on Ugandan macroeconomic data obtained from statistical publications of Bank of Uganda and IMF. E-views 3.0 statistical package was used in estimating the regression model. The study findings reveal that Credit risk, Liquidity, and the Treasury bill rate have a negative relationship with the interest rate spreads in Uganda, while inflation was found insignificant in explaining the high interest rate spreads. On the basis of these findings, it is recommended that while there is still need for more investment in ensuring macroeconomic stability, there is greater need for capacity building within the individual commercial banks’ human and technological resources for better credit risk assessment and management. Moreover, it is imperative that commercial banks reengineer their credit risk control processes by moving from their traditional mechanisms used to control credit risk to loan portfolio restructuring, loan sales and debt-equity swaps. Overall, the study recognizes the importance of a multidimensional approach to any policies directed at tackling the problem of the high interest rate spreads in the Uganda’s Banking system. Finally, the fact that the variables under this study only explain 40% of the response variable is all but evidence for need for more research in this area. To this end therefore, this study could be complimented if more research is carried out on the quality of credit risk management systems and interest rate spreads in Uganda’s Banking system