Yonas Belay Chekol

One of the main functions of financial intermediaries is to channel funds from savers to investors. Net interest margin (NIM) serves as an indicator of performance, more specifically, efficiency of the financial intermediation in the banking industry. A competitive banking system is expected to foster efficiency which should get reflected in lower NIM. Too high NIM is a reflective of lack of competition in the industry. High margins create impediments for the deepening of financial intermediation in the country, as lower deposit rates discourage savings, and high loan rates reduce the investment opportunities of banks. Moreover, high margins may indicate problems in the regulatory banking environment and information asymmetry. The banking sector of Kenya has experienced higher interest margin. The aim of this study was to investigate the determinants of NIM of commercial banks in Kenya. The study employed explanatory approach of longitudinal research design to analyze the data that drawn from 44 banks over the period 2000 to 2009.

The study population comprised all commercial banks in Kenya during the period 2000 - 2009. Secondary data was utilized in analyzing the relationship between the dependent and independent variables. A scatter plots were used to see the existence of functional relationship between the response and predictor variables as primarily evidence. A linear regression model was employed to do empirical analysis of the variables. In the model, NIM defined as a dependent variable whereas  operating expense (OE), credit risk (CR), inflation (INF) and economic growth (GROWTH), and market concentration (CONC) delineated as independent variable. The findings of the study are as follow: (1) Operating expense has a positive and significant effect on net interest margin of the commercial banks in Kenya. (2) Credit risk is tend to be positively associated with net interest margin (3) the study  finds that the higher inflation the larger net interest margin in Kenya and (4) Growth influences net interest margin negatively. (5) Market concentration has a negative and significant influence on net interest margin. The negative impact of market concentration exists in Kenya banking industry is because of foreign banks. To promote lower interest margin in the banking industry of Kenya the study forward a policy recommendation at bank and regulatory or supervisory level. At  the bank level, to register lower interest margins commercial banks need to improve operational efficiency by reducing operating expense using appropriate cost reduction strategies and by enforcement of standards in  credit risk management (CRM) as a means to prevent banks from taking excessive risks. At the regulatory or supervisory level, to get lower interest margins, public policy should be oriented towards creating the necessary market conditions for banks to enhance their efficiency. So this is achieved by favorable economic situations which include lower inflation rate and sustainable economic growth like GDP per capita. In addition, there is a need to reduce market concentration, in turn, make the process of financial intermediation less costly for society as a whole.