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Determinants of commercial bank interest margins and profitability : some international evidence

  • Demirguc-Kunt, Asli
  • Huizinga, Harry

Using bank data for 80 countries for 1988-95, the authors show that differences in interest margins and bank profitability reflect various determinants: bank characteristics, macroeconomic conditions, explicit and implicit bank taxes, regulation of deposit insurance, general financial structure, and several underlying legal and institutional indicators. Controlling for differences in bank activity, leverage, and the macroeconomic environment, they find (among other things) that: 1) Banks in countries with a more competitive banking sector--where banking assets constitute a larger share of GDP--have smaller margins and are less profitable. The bank concentration ratio also affects bank profitability; larger banks tend to have higher margins. 2) Well-capitalized banks have higher net interest margins and are more profitable. This is consistent with the fact that banks with higher capital ratios have a lower cost of funding because of lower prospective bankruptcy costs. 3) Differences in a bank's activity mix affect spread and profitability. Banks with relatively high non-interest-earning assets are less profitable. Also, banks that rely largely on deposits for their funding are less profitable, as deposits require more branching and other expenses. Similarly, variations in overhead and other operating costs are reflected in variations in bank interest margins, as banks pass their operating costs (including the corporate tax burden) onto their depositors and lenders. 4) In developing countries, foreign banks have greater margins and profits than domestic banks. In industrial countries, the opposite is true. 5) Macroeconomic factors also explain variation in interest margins. Inflation is associated with higher realized interest margins and greater profitability. Inflation brings higher costs--more transactions and generally more extensive branch networks--and also more income from bank float. Bank income increases more with inflation than bank costs do. 6) There is evidence that the corporate tax burden is fully passed on to bank customers in poor and rich countries alike. 7) Legal and institutional differences matter. Indicators of better contract enforcement, efficiency in the legal system, and lack of corruption are associated with lower realized interest margins and lower profitability.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1900.

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Date of creation: 31 Mar 1998
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Handle: RePEc:wbk:wbrwps:1900
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  1. John H. Boyd & Bruce D. Smith, 1996. "The co-evolution of the real and financial sectors in the growth process," Working Papers 541, Federal Reserve Bank of Minneapolis.
  2. Gilbert, R Alton & Rasche, Robert H, 1980. "Federal Reserve Bank Membership: Effects on Bank Profits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 448-61, August.
  3. Claessens, Stijn & Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "How does foreign entry affect the domestic banking market?," Policy Research Working Paper Series 1918, The World Bank.
  4. Gary Gorton & Richard Rosen, 1992. "Corporate Control, Portfolio Choice, and the Decline of Banking," NBER Working Papers 4247, National Bureau of Economic Research, Inc.
  5. repec:ner:tilbur:urn:nbn:nl:ui:12-73030 is not listed on IDEAS
  6. Eijffinger, Sylvester C. W. & Huizinga, Harry P. & Lemmen, Jan J. G., 1998. "Short-term and long-term government debt and nonresident interest withholding taxes," Journal of Public Economics, Elsevier, vol. 68(3), pages 309-334, June.
  7. Huizinga, H.P., 1994. "The incidence of interest withholding taxes : Evidence from the LDC loan markets," Discussion Paper 1994-95, Tilburg University, Center for Economic Research.
  8. Demirguc-Kunt, Ash & Maksimovic, Vojislav, 1996. "Stock Market Development and Financing Choices of Firms," World Bank Economic Review, World Bank Group, vol. 10(2), pages 341-69, May.
  9. Talley, Samuel H. & Mas, Ignacio, 1990. "Deposit insurance in developing countries," Policy Research Working Paper Series 548, The World Bank.
  10. Goldberg, Lawrence G. & Rai, Anoop, 1996. "The structure-performance relationship for European banking," Journal of Banking & Finance, Elsevier, vol. 20(4), pages 745-771, May.
  11. Fabozzi, Frank J. & Thurston, Thom B., 1986. "State Taxes and Reserve Requirements as Major Determinants of Yield Spreads among Money Market Instruments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 427-436, December.
  12. Huizinga, H., 1994. "The Incidence of Interest Withholding Taxes: Evidence from the LCD Loan Market," Papers 9495, Tilburg - Center for Economic Research.
  13. repec:dgr:kubcen:199688 is not listed on IDEAS
  14. Allen Berger, 1994. "The Relationship Between Capital and Earnings in Banking," Center for Financial Institutions Working Papers 94-17, Wharton School Center for Financial Institutions, University of Pennsylvania.
  15. Asli Demirgüç-Kunt & Enrica Detragiache, 1997. "The Determinants of Banking Crises: Evidence From Developing and Developed Countries," IMF Working Papers 97/106, International Monetary Fund.
  16. Kolari, James & Mahajan, Arvind & Saunders, Edward M., 1988. "The effect of changes in reserve requirements on bank stock prices," Journal of Banking & Finance, Elsevier, vol. 12(2), pages 183-198, June.
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