The determinants of bank interest rate margins: An international study

Abstract

This paper studies the determinants of bank net interest margins (NIMs) in six selected European countries and the US during the period 1988-1995 for a sample of 614 banks. We apply the Ho and Saunders model (Ho, T., Saunders, A., 1981. The determinants of bank interest margins: theory and empirical evidence. Journal of Financial and Quantitative Analyses 16, 581-600) to a multicountry setting and decompose bank margins into a regulatory component, a market structure component and a risk premium component. The regulatory components in the form of interest-rate restrictions on deposits, reserve requirements and capital-to-asset ratios have a significant impact on banks NIMs. The empirical results suggest an important policy trade-off between assuring bank solvency - high capital-to-asset ratios - and lowering the cost of financial services to consumers - low NIMs. The more segmented or restricted the banking system - both geographically and by activity - the larger appears to be the monopoly power of existing banks, and the higher their spreads. Macro interest-rate volatility was found to have a significant impact on bank NIMs; this suggests that macro policies consistent with reduced interest-rate volatility could have a positive effect in reducing bank margins. © 2000 Elsevier Science Ltd. All rights reserved.