The determinants of bank interest rate margins: an international study

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.     

The effects of focus versus diversification on bank performance: Evidence from Chinese banks

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996–2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus indices, which are based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation may play important mitigating roles. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.     

On the determinants of bank interest margins under credit and interest rate risks

This paper explores the determinants of optimal bank interest margins based on a simple firm-theoretical model under multiple sources of uncertainty and risk aversion. The model demonstrates how cost, regulation, credit risk and interest rate risk conditions jointly determine the optimal bank interest margin decision. We find that the bank interest margin is positively related to the bank's market power, to the operating costs, to the degree of credit risk, and to the degree of interest rate risk. An increase in the bank's equity capital has a negative effect on the spread when the bank faces little interest rate risk. The effect of rising interbank market rate on the spread is ambiguous and depends on the net position of the bank in the interbank market. Our findings provide alternative explanations for the empirical evidence concerning bank spread behavior.     

The impact of taxation on bank profits: Evidence from EU banks

Using bank-level data for the period 1990–2005, we investigate to what extent European banks are able to shift their tax-burden forward. We examine the effects of corporate income tax (CIT) and value added tax (VAT) on pre-tax profits and their components, and find that both are shifted forward. The pass-through mainly involves total operating income, but as far as CIT is concerned it also affects loss provisions, with negative implications on stability of the banking systems.     

The determinants of bank margins in European banking

Most of the theoretical and empirical literature on bank margins has dealt solely with interest margins. Applying the seminal Ho–Saunders model (JFQA, 1981) to a multi-output framework, we show that the relationship between bank margins and market power varies significantly across bank specializations. In this context, European banks are a better laboratory than US banks, since they have generally enjoyed a more flexible regulatory environment in which to provide a wider range of services. Using accounting margins and New Empirical Industrial Organization margins, we find that market power increases as output becomes more diversified towards non-traditional activities in European banking.     

Beyond state-owned banks: Evidence from Shanghai bank customers

In light of a reformed and liberalized banking sector in China, this article sets out to examine the role of socio-demographic factors and customers’ banking experiences and priorities in customers’ selection of banks. As state-owned banks have long dominated the banking industry, the article also investigates the receptiveness of the Shanghai Chinese towards newer commercial banks, such as the joint-stock banks, and the penetration of foreign banks into China's banking industry. Comparing customers who use state-owned banks only and those who patronize joint-stock banks, it is found that education, income, age, occupation sector and location of hometown affects customers of state-owned banks only. Further, it is also found that state-owned banks remain dominant despite the opening up of the banking sector, and perception towards state-owned banks remains favourable.     

Determinants of bank interest margins: Impact of maturity transformation

This paper explores the extent to which interest risk exposure is priced into bank margins. Our contribution to the literature is twofold: First, we extend the Ho and Saunders (1981) model to capture interest rate risk and expected returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit intermediation fees, but reduce (increase) these charges for loans (deposits) when positive excess holding period returns from long-term exposures are expected. Second, we test the model-derived hypotheses not only for the commonly investigated net interest margin but also for interest income and expense margins separately in a sample encompassing the German universal banking sector between 2000 and 2009. Our results suggest that banks price their individual interest rate risk and corresponding expected excess holding period returns via the asset side into the net interest margin. For liabilities, we find that interest rate risk exposure is only priced in by smaller, local banks.     

The determinants of global bank lending: Evidence from bilateral cross-country data

This paper finds that factors determined outside of a country, at the quarterly frequency and especially after 2008, are more closely related to the global bank loans it receives. These loans are generally more stable when global banks face more competition and have a higher presence in the recipient country. We obtain our results by using bilateral lending data from 15 countries and a unique methodology to identify and compare the independent effects of external and internal factors. We identify theoretical mechanisms that can explain our empirical findings and draw more detailed inferences for competition and global bank presence by solving a simple model of global banking.     

International diversification and risk of multinational banks: Evidence from the pre-crisis period

The recent financial crisis has clearly shown that the relationship between bank internationalization and risk is complex. Multinational banks can benefit from portfolio diversification, reducing their overall riskiness, but this effect can be offset by incentives going in the opposite direction, leading them to take on excessive risks. Since both effects are grounded on solid theoretical arguments, the answer of what is the actual relationship between bank internationalization and risk is left to the empirical analysis. In this paper, we study such relationship in the period leading to the financial crisis of 2007–2008. For a sample of 384 listed banks from 56 countries, we calculate two measures of risk for the period from 2001 to 2007 – the expected default frequency (EDF), a market-based and forward-looking indicator, and the Z-score, a balance-sheet-based and backward-looking measure – and relate them to the degree of banks’ internationalization. We find robust evidence that international diversification increases bank risk.     

The management of interest rate risk during the crisis: Evidence from Italian banks

We use a unique dataset to analyze how Italian banking groups managed their exposure to interest rate risk during the recent financial crisis. First of all, we document that on average the interest rate risk exposure – measured by duration gap approach – has been limited and well below the alert level enforced by regulators. Second, our econometric results indicate a relation of substitutability between banks’ on-balance-sheet interest rate risk and their use of interest rate derivatives suggesting that banks used these two instruments to curb their overall interest rate risk exposure in case of an increase in interest rates. Furthermore, we also find robust evidence of a negative correlation between banks’ interest rate risk and liquidity risk.     

The Basel III Net Stable Funding Ratio and bank net interest margins

The Net Stable Funding Ratio (NSFR) is a new Basel III liquidity requirement designed to limit funding risk arising from maturity mismatches between bank assets and liabilities. This study explains the NSFR and estimates this ratio for banks in 15 countries. Banks below the ratio need to increase stable sources of funding and to reduce assets requiring funding. The most cost-effective strategies to meet the NSFR are to increase holdings of higher-rated securities and to extend the maturity of wholesale funding. These changes reduce net interest margins by 70–88 basis points on average, or around 40% of their year-end 2009 values. Universal banks with diversified funding sources and high trading assets are penalized most by the NSFR.     

Domestic and multinational determinants of foreign bank profits: The case of Greek banks operating abroad

This paper examines the determinants of profits of Greek banks operating abroad by developing an integrated model that includes a set of determinants informed by the literature on the profitability of both multinational and domestic banks. The basis for our econometric analysis is provided by an unbalanced panel dataset for 19 Greek bank subsidiaries operating in 11 nations, covering the period from 1995 to 2001. The results show that the profitability of the parent bank and the operating experience of its host nation subsidiaries have a robust and positive impact on the profits of Greek banks abroad, whereas subsidiary bank size has a negative effect. Domestic financial factors reflecting stock market developments, bank-specific factors such as liquidity, loan loss provisions or cost efficiency, and market specific factors like concentration or market share in the host nations, are all insignificant in explaining Greek subsidiary banks’ profits.     

Small European banks: Benefits from diversification?

Motivated by the liberalisation and harmonisation of financial systems in Europe, we investigate whether the observed shift into non-interest income activities improves performance of small European credit institutions. Using a sample of 755 small banks for the period 1997–2003, we find no direct diversification benefits within and across business lines and an inverse association between non-interest income and bank performance. Our findings are robust to a set of sensitivity analyses using alternative samples and controlling for the regulatory environment. Furthermore, the results provide circumstantial evidence for the presence of economies of scale. The absence of benefits of diversification confirms findings for other banking markets and suggests small European banks enter lines of business where they currently lack expertise and experience. These results have implications for bank supervisors, regulators and bank managers.     

The effect of financial market development on bank risk: evidence from Southeast Asian countries

This paper examines how bank risk varies with changes in financial markets development in a broad data set of 52 publicly listed commercial banks in five Southeast Asian countries over a 23-year period between 1990 and 2012. A consequence of two financial crises (i.e. the Asian financial crisis of 1997–1998 and the global financial crisis of 2007–2009) provides a natural experiment in which linkages between financial markets development and bank risk are measured. Empirical results show that higher degrees of financial markets development are associated with weaker bank capital positions and are positively related to higher degrees of bank revenue diversification. There is also evidence for a U-shaped relationship between the degree of financial markets development and bank capital.     

A time series/cross section analysis of the determinants of Australian trading bank loan/deposit interest margins: 1962–1981

A theoretical model of the determination of trading bank interest margins, based on the hedging theory of interest margin determination, is tested on time series cross-section data of Australian trading banks. Generally, the results are consistent with that theory. That is, there exists a stable non-linear relationship between Australian trading bank net loan/deposit interest margins and measures of market power, degree of absolute risk aversion, and to interest rate uncertainty. Furthermore, the shift from business sector to personal sector loan and deposit business is associated with increased bank interest margins.     

The anatomy of bank diversification

We use panel data from nine countries over the period 1996–2008 to test how revenue diversification affects bank value. Relying on a comprehensive framework for bank performance measurement, we find robust evidence against a conglomerate discount, unlike studies concerned with industrial firms. Rather, diversification increases bank profitability and, as a consequence also market valuations. This indirect performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity. We further demonstrate that previous results in the literature on the impact of diversification on bank value presumably differ due to the way diversification is measured, and the negligence of the indirect value effect via bank profitability. Our evidence against a conglomerate discount in banking remains robust also during the sub-prime crisis.     

Loans from my neighbours: East Asian commercial banks,financial integration,and bank default risk

This study investigates the impact of financial integration on recipient country bank default risk and, in particular, if that relationship is moderated by the type of financial integration. Using the system generalized method of moments (GMM), the study finds that financial integration lowers bank default risk in the recipient countries. The impact is primarily driven by the foreign claims extended by Asian lenders and the foreign claims extended via local affiliates. These results show that the close proximity of lenders and borrowers or ‘local’ knowledge via an affiliate presence alleviates information asymmetry, allowing for effective monitoring and disciplining of the loan relationship. The result supports the fostering of financial integration, promoting deeper intra-regional connectedness throughout East Asia. When foreign claims come from outside East Asia, policy makers should encourage presence through local affiliates, as this has an equivalent impact.     

Bond underwriting by banks and conflicts of interest: Evidence from Japan during the pre-war period

Article 65 of the Securities and Exchange Law of Japan, which was carried into effect in 1948, prohibited banks from underwriting corporate securities partially because of the concern that combining the banking and securities businesses might result in a potential conflict of interest. This paper studies the pricing and long-term default performance of industrial bonds underwritten by commercial banks, the Industrial Bank of Japan (IBJ), and trust firms as compared to those underwritten by investment houses during the pre-war period in Japan when banks were allowed to underwrite industrial bonds. The evidence rejects the concern about the conflicts of interest.     

The bank loan distribution effect of government spending expansion: Evidence from China

Rather than focusing on the spread of enterprises' bank loans, we focus on the impact of government spending expansion on the amount of bank loans obtained by enterprises. We first build a theoretical model to show that there are the demand effect and loan cost effect of government spending expansion on the bank loans and then use the fixed effects approach to analyze the bank loan distribution effect of government spending expansion by using the data of enterprises listed on the China Stock Exchange between 2003 and 2019. Empirical results show that the demand effect plays a leading role for the central government state-owned enterprises (SOEs), helping them obtain more bank loans from banks. In contrast, for private enterprises, the loan cost effect plays a leading role, hurting them in obtaining bank loans from banks. Further research shows that government spending expansion's crowding-in or crowding-out effect differs from Neoclassicism and (new) Keynesianism. This paper provides a new explanation for why the financing problem of private enterprises is getting worse in China. The policy implication is that when the government implements expansionary fiscal policies, it should also provide convenience for private enterprise financing through window guidance to prevent the expansionary fiscal policies from crowding out private enterprise bank loans.     

The effect of TARP on the propagation of real estate shocks: Evidence from geographically diversified banks

This study examines the effect of TARP on the propagation of real estate shocks via geographically diversified banks in the U.S. I find that TARP money provided for banks exposed to distressed areas (i.e., “affected” banks) was positively associated with small business loan originations in “non-distressed” areas (i.e., counties with smaller real estate shocks), mitigating the shock transmission. In addition, the bailout funds facilitated “affected” banks’ faster return to their pre-crisis level of franchise value. Overall, the marginal benefit of TARP funds seems to have been greater for “affected” TARP banks. I conclude that this policy helped “affected” banks cleanse/strengthen their balance sheets and recapitalize, which paved the way for increased lending.