financial reforms and interest rate spreads in the commercial.pdf

IMF Staff Papers Vol. 51, No. 1 © 2004 International Monetary Fund Financial Reforms and Interest Rate Spreads in the Commercial Banking System in Malawi EPHRAIM W. CHIRWA and MONTFORT MLACHILA* This study investigates the impact of financial sector reforms on interest rate spreads in the commercial banking system in Malawi. The financial reform program com- menced in 1989 when both the Reserve Bank Act and the Banking Act were revised with the easing of entry requirements into the banking system, and indirect mon- etary policy instruments were subsequently introduced in 1990. The adoption of a floating exchange rate in 1994 marked the end of major policy reforms in the Malawian financial sector. Using alternative definitions of spreads, our analysis shows that spreads increased significantly following liberalization, and panel re- gression results suggest that the observed high spreads can be attributed to high monopoly power, high reserve requirements, high central bank discount rates, and high inflation. [JEL E43, G21, L13] inancial reforms have been a major component of structural adjustment pro- F grams in developing countries. Following the McKinnon (1973)-Shaw (1973) hypothesis, the conventional wisdom is that flexibility and efficiency of the finan- cial system are critical to the growth and development of a market economy. The McKinnon-Shaw hypothesis postulates that government control and intervention in the financial system, which limit the operation of market mechanisms, lead to financial repression, and slow economic growth and development. There has been a large body of empirical work testing the positive relationship between financial *Ephraim Chirwa is Associate Professor at the Department of Economics, Chancellor College, University of Malawi. Montfort Mlachila is an economist in the Policy Development and Review Department of the International Monetary Fund. We would like to tha