The Determinants of Interest Rate Spreads in Developing Countries: Evidence on Tanzania, 1991-2009

Abstract

The now market based financial system in Tanzania is characterized by relatively high interest rate spreads. This paper sought to establish relative importance of macroeconomic and regulatory factors in explaining persistence of interest rate spread in Tanzania during the period 1991:I-2009:IV. A Cointegration and Error Correction Model (ECM) was used to fit the data for Tanzania. The results revealed the interest rate spreads in Tanzania were strongly influenced by net government borrowing from commercial banks, development of the banking sector, statutory minimum reserve requirement and the discount rate. Among others, the results suggest the importance of low discount rate and reduced or total dispense with reserve requirement as a monetary policy strategy to reduce interest rate spreads in Tanzania. Importance of price stability in financial deepening is also underscored by the results.