Expected sign


Lending rate, (il)

Weighted average interest rate on banks loans. This is a price to a borrower.

Independent variables

Operating cost to total assets ratio, opcr

Measures the cost of providing a loan unit by a bank and depends on the productivity of staff and other operating costs. This is the key indicator of efficiency of commercial bank so that the lower the ratio, the higher the efficiency of the commercial bank.


Cost of funds

Deposit interest rate, id is use to capture the cost of funds for a bank computed as weighted average interest rate on retail deposits by each bank.


Return on assets, ras

Increasing return on assets is likely to enhance bank’s ability to cushion its assets against unexpected risks thus reducing lending rates.


Default risk

It measures the effect on lending of a possibility of default due to a change in the financial health or condition of the borrower following normal or unexpected swings in the overall level of economic activity. Default rate on total loan and advances is proxied by non-performing loans to total loans ratio (nplr).


Bank size

Computed as a ratio of bank’s assets to industry total assets (siz), it captures the effect of bank’s size on lending rate. As the size of a bank increases the likely that it will be able to cushion it’s assets from falling following unexpected occurrences and can meet its loan obligations with less difficulties.

Another candidate variable in this area is liquid assets to total assets (lqr). Liquid assets comprise vault cash, treasury bills and bonds, bills receivable, clearing account balances and claims on banks.


Bank rate (monetary policy effect)

Proxied by weighted average treasury bills rate (itbl) to capture the influence of monetary policy stance on lending rate. An increase in the central bank rate will signal policy tightening to commercial banks, thus lending rate or interest rate spreads are expected to increase.


Regulatory constraints

Proxied by statutory minimum requirement (smr) to capture effects of regulatory requirements on lending rate. Another variable that could explain severity of regulation is provision for bad loans as a ratio of total loans (provr).


Market concentration

Market concentration (comp) approximates the level of competition in an industry, with lower market concentration resulting in higher competition thus pushing down spreads. HHI is used to measure degree of concentration, computed as the sum of squared market shares of all the firms in the market scaled from 0 to 10,000.



Inflation (infl) is used as the cost of doing the business in the economy. High levels of inflation are expected to lead to high lending rates or interest rate spreads as it causes banks to charge a risk premium. Also, when the general prices of goods and services increase these lead to significant reduction in disposable income and the purchasing power of income earners. This ultimately leads to low level of savings and high rate of loan defaults, negatively affecting the financial performance of lenders.


Real GDP

Growth of economic activity (rgdp) can affect lending rates by: increasing the demand for loans leading to high lending rates; and by making projects more profitable which reduces defaults and increase the deposits that further reduce interest rate spreads.