An Empirical Analysis of Interest Rate Spreads in Tanzania

This paper investigates bank characteristics and macroeconomic factors responsible for widening interest rate spreads in Tanzania following liberalization and reform of the financial system in 1991. The paper uses quarterly time series data covering the 1986–2013 period. At the empirical level, Johansen test and Engle-Granger (two-step) single equation procedure are used for cointegration analysis. The Error Correction Modeling is employed to estimate the model. The results reveal that interest rate spreads are significantly higher after the adoption of financial liberalization if compared with the period before liberalization. The results also reveal that interest rate spreads are significantly determined by lack of competition among financial institutions; and existence of diseconomies of scale in the financial system. Moreover, it is established that as proportion of liquid assets increases the bank liquidity risk decreases, leading to lower interest rate spreads. Since high interest rate spreads reflect lack of competitiveness and inefficiency in the financial system, policies should be directed at improving risk management, building a prudential level of liquid assets, strengthening supportive information and bank supervision, and maintaining macroeconomic stability.