Issues Relating to Interest Rate Spread in Commercial Banking System of Sri Lanka

Abstract

An efficient and vibrant commercial banking and financial system are essential ingredients for any market economy to become successful. It is expected to provide lifeblood to the efficient and effective functioning of an economy. Commercial banks mobilize savings by offering various types of deposit products to savers and channel such savings as loans and advances to borrowers and investors. The difference between the rates at which banks lend money to borrowers and the rate they are paying to depositors are generally known as ³LQWHUHVWUDWHVSUHDG´ ,56 7KHHIILFLHQF\RIWKHEDQking system is reflected by series of financial indicators and more importantly by IRS and Net Interest Margin (NIM). IRS is an important indicator of efficiency level of a bank or a banking system. It reflects profit maximizing ability of the financial intermediaries. The Central Bank of Sri Lanka repeatedly expresses its concern on IRS in the recent past. This is due to relatively higher IRS in Sri Lanka than other countries in the South Asian region. High IRS is causing high cost to borrowers and investors. On the other hand, it reduces the deposit income of the depositors. Thus, the objective of the present study is to identify the factors that are contributing to high interest rate spread in Sri Lanka and identify actions needed to reduce the spread