Abstract
This paper uses bank level data of 26 commercial banks for the period 2001–2010 to explore determinants of net interest margins of commercial banks of Pakistan. Based on results of this study, past net interest margins, bank soundness, operating cost, industry concentration, relative market share, inflation, real depreciation and industrial growth have statistically significant and positive impact while diversification, change in bank size, lagged liquidity, stock market development have dampening effects on net interest margins. However, impact of ownership, GDP and credit market development is statistically insignificant. Our regression results suggest that stock market development as means of alternative source of finance contributes to reduction in net interest margins while the impact of banking sector development on breaking banking cartels and bringing net interest margins down had been insignificant. Exchange rate adjustments, rate of inflation and growth of the industry also cannot be ignored in management of net interest margins. Incentives for bank executives and managers to ensure efficiency in operating costs, reduction in the premium charged for bank soundness, diversification of bank activities and passing on the scale efficiencies to both depositors and borrowers can also play role to bring interest margins down to accelerate investment and growth in the country.
Highlights
High interest margins are reflective of higher intermediation costs to the society and might be indicative of systematic problems like concentrated banking industry, perceived market and credit risks, bank unsoundness, scale diseconomies, high operating costs, unfavourable institutional environment and distortions in markets (Poghosyan 2012)
Well functioning intermediaries support growth of the economy (Levine 1997), net interest margins (NIMs) are indicative of the efficiency/ effectiveness of the intermediaries to channelize the funds in the system (Tan 2012)
Results of our model suggest that higher inflationary pressure is translated to higher NIMs in Pakistan
Summary
High interest margins are reflective of higher intermediation costs to the society and might be indicative of systematic problems like concentrated banking industry, perceived market and credit risks, bank unsoundness, scale diseconomies, high operating costs, unfavourable institutional environment and distortions in markets (Poghosyan 2012). Evidence on impact of net interest margins (NIMs) on economy. Jayaatne and Strahan (1996), Rajan and Zingales (1998) and Beck et al (2000) provide evidence on repercussions of intermediation costs (and NIMs) on economic activity. Khediri and Ben-Khedhiri (2011) highlight that net interest margin, among other variables; can impede economic activity of a country. Well functioning intermediaries support growth of the economy (Levine 1997), net interest margins (NIMs) are indicative of the efficiency/ effectiveness of the intermediaries to channelize the funds in the system (Tan 2012). Discussion highlights the role and significance of NIMs for economic growth of a country. Understanding of the determinants of NIMs assists us in monitoring the efficiency of the financial intermediaries (Hawtrey, Liang 2008)
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