Determinants of interest rate in emerging markets. A study of banking financial institutions in Uganda
| Published date | 10 September 2018 |
| Pages | 267-290 |
| Date | 10 September 2018 |
| DOI | https://doi.org/10.1108/WJEMSD-10-2017-0070 |
| Author | Sulait Tumwine,Samuel Sejjaaka,Edward Bbaale,Nixon Kamukama |
| Subject Matter | Strategy,Business ethics,Sustainability |
Determinants of interest rate
in emerging markets
A study of banking financial institutions
in Uganda
Sulait Tumwine
Department of Accounting,
Makerere University Business School, Kampala, Uganda
Samuel Sejjaaka
ABACUS Business School, Kampala, Uganda
Edward Bbaale
Makerere University, Kampala, Uganda, and
Nixon Kamukama
Mbarara University of Science and Technology, Mbarara, Uganda
Abstract
Purpose –The purpose of this paper is to investigate the determinants of interest rate in emerging markets,
focusing on banking financial institutions in Uganda.
Design/methodology/approach –Using the net interest margin model, interest rate was estimated by
applying a panel random effects regression method on 24 banks, while controlling for bank-specific factors,
industry and macroeconomic indicators. Data were drawn from annual reports provided by Bank of Uganda
Depository Corporation survey from 2008 to 2016.
Findings –The results indicate that liquidity, equity capital, market power and reserve requirement have a
positive effect on interest rate. The study further finds that operational efficiency, lending out ratio,
concentration, public sector borrowing and private sector credit have a negative effect on interest rate.
However, credit risk does not influence interest rate.
Research limitations/implications –Studied banks are grouped in one panel data set; future studies
would focus on the differences in banks and establish how these differences affect interest rate. Future study
would also focus on how the determinants of interest rate in Uganda are compared with those of other banks
in other emerging market countries.
Practical implications –Bank managers need to take interest in equity mobilization because it is a reliable
and cheaper source of funding bank operations. Banks should emphasize efficient operationsto reduce on the
cost of doing business. Government should utilize funds borrowed from banks in efficient ways to improve
economic growth. The central bank should minimize the use of reserve requirement as a means of controlling
money in circulation.
Originality/value –This is the first paper that uses annual report data from several banks and periods to
investigate the determinants of interest rate in an emerging country.
Keywords Interest rate, Macroeconomic indicators, Bank-specific factors, Industry-level factors
Paper type Research paper
1. Introduction
In the last few decades, the banking sector in Uganda has experienced high interest rates
which have endangered economic growth and development. High interest rates limit
financing for potential borrowers (Ndung’u and Ngugi, 2000), affect economic visibility in
terms of an “equity trap”and create harmful notion that investment is a high risk business
(Folawewo and Tennant, 2008a). This is detrimental to the return on savings and
investment by entrepreneurs and individual households thereby damaging private equity.
Loss of capital by entrepreneurs who fail to meet their financial obligations means that there
is minimal capital multiplier effect from past investment; this hinders economic growth
and development.
World Journal of
Entrepreneurship, Management
and Sustainable Development
Vol. 14 No. 3, 2018
pp. 267-290
© Emerald PublishingLimited
2042-5961
DOI10.1108/WJEMSD-10-2017-0070
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/2042-5961.htm
267
Determinants
of interest rate
in emerging
markets
As a response to the devastating consequences of continued high interest rates charged
by banking financial institutions (BFIs), considerable effort has progressively been devoted
to set down remedies aimed at managing such high rates. For example, since 1990 to to-date,
the Government of Uganda has started pursuing structural adjustment programs (SAPs)
with the aim of improving efficiency in the economy including the banking sector. The SAPs
interventions undertaken included liberalization of the monetary sector to create sound
macroeconomic environment, removal of controls on interest rate determination by BFIs
and elimination of all foreign exchange controls (Kuteesa et al., 2010). These interventions
have caused economic stability, increase in the number of banks and their branches,
increase in total bank assets, profitability and has enabled cheap sources of funds available
for lending as low as 8 percent and increase in the number of banks. Despite these positive
factors, interest rate charged by BFIs in Uganda has remained high above 23 percent.
Earlier studieson interest rate have focused on macroeconomic indicators( Folawewo and
Tennant, 2008b), their findings are inconclusive. As Were and Wambua (2015) indicated, not
all macroeconomic indicators have a transmission and spillover effect on interest rate.
Furthermore, prior studies have ignoredthe effect of industry-specific factorson interest rate
(Osei-Assibeyand Asenso, 2015), while other studies by and Beck and Hess(2006) focused of
industry-specific factors but ignore bank internal factors on interest rate Almarzoqi and
Naceur (2015).Although there is empirical work linkingbank-specific factor, industry-specific
factors and macroeconomic indicators to interest rate, they have concentrated on country
comparison usingtime series while others focused on macroeconomic indicators. The studies
by Anamika and Kumar(2016) and Almarzoqi and Naceur (2015) focused on macroeconomic
and bank factors alone, while the study by Ahokpossi (2013) concentrated on the
determinants of bankinterest margins in Sub-Saharan Africa. Central to the observations by
previous scholars, the focus of their studies was on country-level comparisons using
nationwide data and time series and studying a few variables. Thus, this study is not a
duplication of the earlier studies, but rather aims at establishing thedeterminants of interest
rate at the bank level using panel data and by taking into account the three variables (bank-
specific factors, industry-specific factors and spillover effects of macroeconomic indicators).
This study introduces new dimensions in bank-specific factors (liquidity, operational
efficiency, credit risk, capitalization and lending out ratio); industry-specific factors
(concentration and market power) and spillover macroeconomic indicators (public sector
borrowing, reserve requirement and private sector credit) that have not been studied as a
whole and how they influence interest rate in a given country.
The study results are expected to enable scholars, policy makers and practitioners
have a more definite and direct understanding of the impact of bank-specific factors,
industry-specific-level factors and macroeconomic indicators on interest rate in BFIs.
This will probably guide decision makers on the optimal interest rate for the maximum
maximize utility of resources borrowed by the individual and private sector for economic
growth and development.
The rest of the paper is organized as follows. Section 2 presents empirical literature.
Section 3 describes the data. Results and discussion are presented in Section 4, while Section
5 concludes as well as provides policy implications and areas for further research.
2. Literature review
2.1 Theoretical literature review
This study is guided informed by the theory of interest rate (Fisher, 1930) which provides
that interest rate is a deviation from the price of the present money in terms of future money
due to expected inflation. A common linear representation, i¼r+π(where iis interest rate,
ris ex ante real interest rate and πis expected rate of change in price level), is a result of
productivity of capital, labor and investor time preference in an economy. The theory
268
WJEMSD
14,3
To continue reading
Request your trial