Causes of high interest rate spreads in banks

Over the past few years, from 2023 to 2025, interest rate spreads in Nigerian banks have notably increased, reaching a record high from 6 percent to 19 percent, as reported by The CFG Advisory.

The interest rate spread refers to the difference between the rates banks charge on loans and those they offer on deposits. This issue has been a concern since the liberalisation of the Nigerian banking system. The unusually wide spreads, especially when compared to regional and global banking standards, suggest that there are fundamental inefficiencies within Nigeria’s banking sector and broader economic distortions. Furthermore, stringent monetary policies and a restrictive regulatory environment are also influencing the widening of these rate spreads, ultimately impacting the economy.

The report, titled ‘Adverse Effects of High Interest Rate Spreads on the Nigerian Economy’, was authored by Mustafa Chike-Obi, Chairman of the Bank Directors’ Association of Nigeria (BDAN), and Adetilewa Adebajo, CEO of The CFG Advisory. It highlights that high interest rate spreads in Nigerian banks have significant consequences for the country’s economic stability and key economic indicators.

Wider spreads often signal structural inefficiencies, increased risks, or restrictive monetary conditions that hinder economic performance. In contrast, narrower spreads reflect a competitive, well-functioning financial system that supports economic growth and stability. The report aims to explore the causes, impacts, and potential strategies for reducing interest rate spreads in Nigerian banks.

Regulatory Requirements, Charges and Taxes

The Central Bank of Nigeria’s regulatory requirements, particularly the high Cash Reserve Ratio (CRR) at 50 percent and the Liquidity Ratio, have contributed to the widening of interest rate spreads by limiting the amount of funds available for lending.

In addition to these, banks are burdened with various levies, including the AMCON levy, NDIC premiums, and the upcoming windfall tax. These additional costs are passed on to customers through higher loan interest rates, further increasing the interest rate spread.

Monetary Policy Stance

Monetary policy decisions by the Central Bank of Nigeria also play a pivotal role in shaping the interest rate spread. Tight monetary policies, such as high benchmark rates, directly influence the lending rates set by banks. The Monetary Policy Rate (MPR) is a key factor in this dynamic, and when the MPR is increased to tackle inflation, it leads to higher lending rates, which in turn widen the interest rate spread.

Liquidity and Funding

Banks’ access to affordable funding and liquidity is another significant factor influencing interest rate spreads. When banks face liquidity constraints or high borrowing costs, they are compelled to raise their loan interest rates to maintain profitability, which results in higher interest rate spreads.

High Credit Risk

A high level of non-performing loans (NPLs) in the banking sector also forces banks to charge higher interest rates to mitigate the risk of default. Additionally, Nigerian banks often factor in a risk premium due to the perceived higher lending risks in the country, which further contributes to the widening of the interest rate spread.

Impact of High-Interest Rate Spreads on the Economy

High interest rate spreads have far-reaching consequences for the economy. The most direct impact is on investment. When interest rates are high, borrowing for productive investments becomes less attractive, which can lead to a stagnation in economic growth. Businesses and individuals are less likely to take on loans for new ventures or expansion, reducing overall investment in the economy.

The high cost of borrowing also limits access to credit, particularly for small and medium enterprises (SMEs) and individuals in rural or underserved areas. This lack of affordable credit stifles economic opportunities for these groups, limiting their ability to expand businesses, create jobs, or invest in new projects, which in turn slows down broader economic growth.

Increased borrowing costs raise operational expenses for businesses, diminishing their profitability and competitiveness. This further discourages borrowing, leading to reduced demand for loans and a slowdown in economic activity.