The financial sector reforms and interest rate spread: The Tanzania’s Experience

This study makes use of time series (data) technique to uncover the main determinants of the bank interest spreads in Tanzania for the 1986-2002 period. In estimating the model we first test for cointegration using the Johansen procedure, and a general-to¬ specific procedure is applied to obtain a parsimonious model. We find that in the long run, interest rate spread is negatively related to liquidity, decomposition of deposits and the ratio of non-interest bearing deposits to total operational asset, and positively related to size of the banking system. In addition, the role-played by discount rate and inflation are highlighted. The results suggest that bank discount rate is the most relevant macroeconomic variable to explain the behaviour of bank interest spread in Tanzania. The results warrant some policy recommendations. Since high interest spreads reflect lack of competitiveness and inefficiency in the financial system, policy should be directed at improving financial management, strengthening of supportive information and bank supervision. Tanzania like any other developing country should maintain macroeconomic stability, for instance reduction in the central bank discount rate would be necessary to reverse the widening trends in interest spreads in the liberalized financial system.