This study analyses the interest margin in the principal European banking sectors (Germany, France, the United Kingdom, Italy and Spain) in the period 1993-2000 using a panel of 15,888 observations, identifying the fundamental elements affecting this margin. Our starting point is the methodology developed in the original study by Ho and Saunders (1981) and later extensions, but widened to take banks' operating costs explicitly into account. Also, unlike the usual practice in the literature, a direct measure of the degree of competition (Lerner index) in the different markets is used. The results show that the fall of margins in the European banking system is compatible with a relaxation of the competitive conditions (increase in market power and concentration), as this effect has been counteracted by a reduction of interest rate risk, credit risk, and operating costs.

IVIE working-papers offer in advance the results of economic research under way in order to encourage a discussion process before sending them to scientific journals for their final publication. ___________________ • The authors wish to thank David B. Humphrey for his comments and suggestions, and Juan Fernández de Guevara for his help in preparing information. The paper is part of project SEC98-0895 of the CICYT.

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