Banking: Interest spread, inelastic deposit supply, and mergers

Abstract

Interest spread of Pakistan's banking industry has been on the rise for the last two years. The increase in interest spread discourages savings and investments, on the one hand, and raises concerns on the effectiveness of bank-lending channel of monetary policy, on the other. This study examines the determinants of interest spread in Pakistan using panel data of 29 banks. The results show that inelasticity of deposit supply is a major determinant of interest spread whereas industry concentration has no significant influence on interest spread. One reason for inelasticity of deposits supply to the banks is the absence of alternate options for the savers. The ongoing merger wave in the banking industry will further limit the options for the savers. Given the adverse implications of banking mergers for a competitive environment, we argue that to maintain a reasonably competitive environment, merger proposals may be subjected to review by an antitrust authority with the central bank retaining the veto over merger approval.