Interest Rate Spread

Interest rate spread in a financial system refers to the difference between the average lending rate and the average deposit rate in that financial system (World Bank, 2004). In Figure 9 below the interest spread for Tanzania is presented, and the comparison with Kenya and Uganda is made, while also the benchmarking against the LIC and SSA data is made, to show how the level of Tanzania compares with countries of similar level of development.

Figure 9: Interest Rate Spread 1995-2003

Source: World Bank (2014) World Development Indicators

0 5 10 15 20 25

1995 1996 1997 1998 1999 2000 2001 2002 2003

Interest rate spread

Years

Interest Rate Spread 1995-2003

UGA TZA LIC SSA KEN

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In the graph of interest rate spread, we notice that in our first year of observation and in the following six years, the spread for Tanzania was higher than those of Kenya and Uganda, as well as those of SSA and LIC. We note also that the maximum spread was in the year 1996, which is the time when the biggest bank in the country, the NBC was undergoing its restructuring. The restructuring of NBC caused the immediate effect of reduction of financial services because of closure of the loss making branches in the areas of comparatively less economic activities.

We notice also that from 1996 up to the year 1999 there was a slow but regular decline of the level of the spread from 20.3% to 14.14%, followed by an increase in the following two years 2000 and 2001. Interest rate spread then declined to 11.5% in 2003.

In the early years of reforms it was clear that the gap of the spread between Tanzania and the East African neighbors, Kenya and Uganda was wider than in the year 2003, when Tanzania had a lower spread than Kenya, and was almost at the same level with the regional averages, while slightly higher than Uganda.

The data for spread shows that during the period of reforms there was a constant improvement in the level of spread. This may be due to the entry of private financial institutions and the restructuring of the biggest bank – the NBC – which led to the split of the bank into NBC 1997 Ltd and NMB Bank, which definitely increased competition. Even then Tanzania, Kenya and Uganda need to do more in this respect, as the spread above 10% is still high.

I will examine the profitability of the banks, which have been mentioned above to be connected in a way with lack of competition and inefficiency in the financial sector, which in turn contribute to the high spread.

69 4.4.2.2.1 Return on Equity

Figure 10 Return on Equity

Source: World Bank (2014) World Development Indicators

This study noted that the BOT uses the fact that banks in Tanzania have got high profit margin to be a point that demonstrate the healthy position of the operations of banks. I will take that with reservations, because the high profit margins are not obtained in an environment where the interest rate spreads are so high. So, high profit margin may be a symptom of inefficiency that ensue due to lack of competition.

Figure 10 above shows the return on Equity for Tanzania. Return on Equity is a measures of profitability against the shareholders’ funds invested in the business.

𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥

𝑂𝑤𝑛𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦 𝑝𝑙𝑢𝑠 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠,

In figure 9 the actual data for ROE in Tanzania are given, and for comparison purposes, the corresponding figures for Kenya and Uganda, as well as the averages for LIC and SSA for benchmarking purposes. The data available for all these countries are from the year 1999. For the first three years, Uganda recorded the higher profit margin (41% in 1999, 63.14% in 2000 and 54% in 2001) than the regional neighbours(for Tanzania and Uganda respectively 32.3%

0

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and 6.72% in 1999, 35.18% and 14.2% in 2000, and 35.47% and 19.87% in 2001)and the averages for the SSA and LIC (for LIC and SSA respectively 14.7% and 15.17% in 1999, 21.22% and 19.15% in 2000 and 20.7% and 19.95 in 2002). We note that Tanzania was always the second in those three years after Uganda. For years 2002 and 2003 Tanzania recorded the higher profit margins than the neighbours in East Africa with ROE 39.68% in 2002 and 44.18%

in 2003. Uganda had ROE of 20.06% in 2002 and 37.87% in 2003, whereas Kenya had 3.05%

in 2002 and 16.72% in 2003. The averages of ROE for SSA and LIC were also lower than the corresponding Tanzanian figures.

4.4.2.2.2 Return on Assets

Returns on Assets is another measure of profitability. It measures how best the financial institution puts the assets at its disposal to a good use. 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑇𝑎𝑥

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

In figure 11, the figures for Returns on Assets for Tanzania as well as Kenya and Uganda are presented, and the averages for SSA and LIC are provided as well.

Figure 11: Return on Assets after Tax

World Bank (2014), World Development Indicators

The pattern is similar to that of ROE, both in Trend and in the way the countries compare.

We note, however, that in 2003 Uganda had a marginally higher ROA of 3.21% compared to

0

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Tanzania’s 3.17% for the same year, whereas the ROE for the same year was higher for Tanzania than Uganda.

We note also, that Tanzania had consistently higher ROA than the averages for SSA and LIC, but was closing the gap with time.

The figures for ROE in Tanzania show that there was an environment that created the possibilities of the financial institutions to earn higher profit margins than the average margins for SSA and LIC.