INFLUENCE OF FINANCIAL DEPTH ON FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN RWANDA

The link between banking development and economic growth has long received significant attention in research, however, the waves of banking development cannot raise the tide of the economy without affecting financial performance of commercial banks; it is against this background that this study was formulated with the main objective of establishing the influence of Financial Depth on financial performance of commercial banks in Rwanda. In this paper financial depth was proxied by Broad money and credit to private sector, financial performance proxied by return on Assets (ROA), and both moderated by inflation proxied by consumer price index. This study collected and analysed both primary and secondary data. The study concluded that financial depth has a positive and significant influence on financial performance of commercial banks in Rwanda. Interestingly enough, this study found that credit to private sector negatively influence profitability of commercial banks in Rwanda due to rising NPL’s, meaning that the commercial banks in Rwanda are venturing in more riskier lending practices. Bank deposits which was a measure of banking sector liquidity was found to be positively influencing profitability but negatively influencing cost of intermediation measured by net interest margin indicating efficiency in the banking sector. To that end Broad money and inflation also had significant influence on ROA, and therefore the study recommends that unless bank profitability depends on whether inflation expectations are fully anticipated. An inflation rate fully anticipated by the bank’s management implies that banks can appropriately adjust interest rates in order to increase their revenues faster than their costs and thus acquire higher economic profits. The study recommends that commercial banks in Rwanda need to reduce problem assets as high nonperforming loans dampen banks’ potential lending capacity and, by extension, their ability to build up capital buffers. On inflation, full anticipation is required, because an inflation rate fully anticipated by the bank‘s management implies that banks can appropriately adjust interest rates in order to increase their revenues faster than their costs and thus acquire higher economic profits.