Impact of regulatory capital on bank interest margins: Moderating role of default risk

Abstract

The recent pandemic and aftermath debate regarding bank interest margins deserve special attention and have become policy dialogue in emerging economies. However, the previous literature's findings were largely inconclusive and ignored influential variables such as the impact of default risk on bank interest margins. Using a two-step system GMM estimation considering 32 Bangladeshi commercial banks from 2000 to 2022, we produce robust evidence that higher regulatory capital restrictions reduce the bank interest margin, while increased default risk induces the bank interest margin. The impact intensity during the COVID pandemic is higher than in the pre-COVID period. Moreover, we find the synergy effect of regulatory capital and default risk assists in reducing the bank interest margin. Bank margin persistently fell during the capital market crash period, whereas it rose in the financial crisis period. We cast several robustness tests to confirm our main findings. These findings could generate important implications for bank stakeholders and policymakers.