The Determinants of Bank Interest Margins: A Note

Allen, Linda

doi:10.2307/2330883

Cited by 218 publications

(164 citation statements)

References 3 publications

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“…To incorporate the resulting valuation risk, loans and deposits are modelled as fixed-rate contracts, and we adopt the price notation of Ho and Saunders (1981) and Allen (1988). To keep the bank's risk management decision simple, we focus on the provision of a single loan and a single deposit, with differing sensitivities to IRR.…”

Section: Theoretical Modelmentioning

confidence: 99%

Determinants of bank interest margins: Impact of maturity transformation

Entrop

Memmel

Ruprecht

et al. 2015

Journal of Banking & Finance

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This paper explores the extent to which interest risk exposure is priced in bank margins.Our contribution to the literature is twofold: First, we present an extended model of Ho and Saunders (1981) that explicitly captures interest rate risk and returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit rates, but reduce these charges when they expect returns from maturity transformation. Second, using a comprehensive dataset covering the German universal banks between 2000 and 2009, we test the model-implied hypotheses not only for the commonly investigated net interest income, but additionally for interest income and expenses separately.Controlling for earnings from bank-individual maturity transformation strategies, we find all banks to charge additional fees for macroeconomic interest volatility exposure. Microeco- Non-technical summaryBanks are intermediaries between investors and entrepreneurs. They transform long-term, illiquid and risky loans into safe deposits that are due within short notice. By doing so, they take risks, for which they are remunerated. Besides, they can generate income by making use of their market power and by setting their credit and deposit conditions accordingly. In a theoretical model, we show that the bank rates are set in accordance with the costs and earnings caused by the loans and deposits. In addition, banks levy premia for credit and interest rate risk, and for the access to the capital market. We derive the following empirically testable hypotheses:The margins on the asset side should be the higher, the stronger the market power, the more volatile the interest rates and the credit risk and the greater the exposure to interest rate risk.The model also predicts that banks smooth their interest rates (relative to the interest rates observed on the capital market). Accordingly, on the liability side, we expect the same factors to have an impact, expect for the credit risk, which is here not relevant. In an empirical study of all German universal banks for the period 2000 -2009, we obtain the following results:1. The statements derived from the theoretical model can be confirmed in our study, in particular we find that the higher the market power the higher the interest income margin and the lower the interest expense margin.2. The interest rate margins increase for all banks, in the event that the interest rates become more volatile. Additionally, for banks from the savings and credit cooperative sectors, we see the smoothing of bank rates that is predicted by the theoretical model. Nichttechnische Zusammenfassung

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Section: Theoretical Modelmentioning

confidence: 99%

Determinants of bank interest margins: Impact of maturity transformation

Entrop

Memmel

Ruprecht

et al. 2015

Journal of Banking & Finance

View full text Add to dashboard Cite

show abstract

“…Angbazo, 1997;Saunders and Schumacher, 2000;Maudos and de Guevara, 2004;Carbó and Rodriguez, 2007;Hawtrey and Liang, 2008;Maudos and Solís, 2009;Poghosyan, 2010;Fungáčová and Poghosyan, 2011;Lin et al, 2012). The literature has also provided theoretical microeconomic approaches to optimal interest margin setting (Allen, 1988;Angbazo, 1997;Maudos and de Guevara, 2004;Maudos and Solís, 2009). Another comprehensive study on the determinants of interest margins is proposed by Beck and Hesse (2009) enlightening four major perspectives which determine interest margins and spread: i) risk-based view concerning the compensation for the riskiness of loans, ii) small financial system focuses on the fixed cost component of financial service provision and the resulting scale economies, iii) market structure matters for competitiveness and ownership structure of the banking market, iv) macroeconomic view reveals that spreads and margins are affected by monetary and exchange rate policies as well as economic cycles.…”

Section: Literature Reviewmentioning

confidence: 99%

Why Have Bank Interest Margins Been so High in Indonesia Since the 1997/1998 Financial Crisis?

2012

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We investigate the determinants of net interest margins of Indonesian banks after the 1997/1998 financial crisis. Using data for 93 Indonesian banks over the 2001-2009 period, we estimate an econometric model using a pooled regression as well as static and dynamic panel regressions. Our results confirm that the structure of loan portfolios matters in the determination of interest margins. Operating costs, market power, risk aversion and liquidity risk have positive impacts on interest margins, while credit risk and cost to income ratio are negatively associated with margins. Our results also corroborate the loss leader hypothesis on cross-subsidization between traditional interest activities and non-interest activities. Stateowned banks set higher interest margins than other banks, while margins are lower for large banks and for foreign banks.JEL Classification: G21, G28, G32

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“…They find that this "pure interest margin" depends on the degree of management risk aversion, the size of bank transactions, the banking market structure, and interest-rate volatility, with the rate volatility dominating the change in the pure interest margin over time. Allen (1988) extends the single-product model of Ho and Saunders to include heterogeneous loans and deposits, and posits that pure interest spreads may be reduced as a result of product diversification. Saunders and Schumacher (2000) apply the dealer model to six…”

Section: Literature Reviewmentioning

confidence: 99%