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How bank business models drive interest margins: Evidence from U.S. bank-level data

Listed author(s):
  • Saskia van Ewijk
  • Ivo Arnold

The two decades prior to the credit crisis witnessed a strategic shift from a traditional, relationships-oriented model (ROM) to a transactions-oriented model (TOM) of financial intermediation in developed countries. A concurrent trend has been a persistent decline in average bank interest margins. In the literature, these phenomena are often explained using a causality that runs from increased competition in traditional segments to lower margins to new activities. Using a comprehensive dataset with bank-level data on over 16,000 FDIC-insured U.S. commercial banks for a period ranging from 1992 to 2010, this paper qualifies this chain of causality. We find that a bank's business model, measured using a multi-dimensional proxy of relationship banking activity, exerts a robust, positive effect on interest margins. Relationship banks still enjoy considerable interest margins. Our results provide evidence that banks' quest for growth, not the level of competition in traditional retail segments, has transformed banks' balance sheets and has reduced interest rate margins as a by-product.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 387.

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Date of creation: Aug 2013
Handle: RePEc:dnb:dnbwpp:387
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