The sensitivity of banks’ net interest margins to interest rate conditions in CESEE

Since the global financial crisis, the relationship between monetary policy and banks’ net interest margins (NIMs) has been investigated in many studies, not least in light of the low interest rate environment. However, to our knowledge, this is the first econometric study that explores this topic for the Central, Eastern and Southeastern European (CESEE) economies. Using banklevel data for 15 CESEE countries from 2006 to 2018, we assess the effect of the interest rate environment on banks’ NIMs. Our policy rate variable takes into account both the domestic and the international interest rate environment (euro area, U.S.A. and Switzerland). To construct this variable, we use the shares of foreign and domestic currency loans in total bank loans extended to the domestic private sector as weights for the interbank rates of the different jurisdictions. Our results show that lower (weighted) interest rates lead to lower NIMs and that the effect is nonlinear, i.e. it becomes more pronounced as the level of interest rates falls. This finding is in line with the existing literature on other, more advanced economies. As net interest income (NII) is the key revenue component of banks, especially given the traditional lending and deposit-taking business model prevalent in the CESEE banking sectors, we conclude that both pressures on NIMs and the development of interest rates in the region and worldwide should be monitored closely.