Interest banking spreads in Oman and Arab GCC

Abstract

PurposeAverage bank net interest margins vary widely across Gulf Cooperation Council (GCC) countries, net interest margins of Omani banks are significantly higher. The resultant low level of financial intermediation implies reduced investment and economic growth. Understanding the reason for these high and persistent spreads is important to develop a policy for improving effectiveness of the banking system. The paper aims to discuss these issues.Design/methodology/approachNet interest margins of Arab GCC banks during the period 1999-2012 are examined using the balanced panel regression model with bank specific, financial/market structure specific and macroeconomic factors as determinants. The method used for estimation used is the estimated generalized least squares (EGLS) method with both fixed effects and random effects.FindingsBank-specific variables, which explain net interest margins in GCC, are bank capitalization ratios, loan ratios and overhead expenses. Spread of banking sector (as measured by ratio of total bank credit to GDP) is positive and highly significant, implying that along with the expansion of the banking sector in GCC economies, interest margins of banks also improved. Omani banks were able to increase interest margins by aggressively marketing high yield personal and credit card loans, and, zero interest paying deposit products. The study also finds a negative relationship between concentration and net interest margin, and attempts to explain this finding which is at variance with other country studies using the price leadership model of oligopoly.Research limitations/implicationsThe standard, accepted econometric model of net interest margins which has been used in earlier studies is unable to explain the high net interest margins of banks in Oman although it is able to explain interest margins in other GCC countries. There is a need to develop non econometric models. More work is needed on the implications of NIM spreads for how they affect an economy.Practical implicationsThe study shows that as the banking sector spreads in the economy, individual banks have more opportunities to market their products while at the same time maintaining interest margins. Bank managements should note this point and look for opportunities to expand.Originality/valueThere is no evidence of any empirical studies which focused on net interest margins in the GCC countries. This study attempts to fill in this gap with a view to nudge policy makers to look at the issue of high interest margins and its detrimental impact on economic growth and development in the Gulf region. The paper is useful for policy makers to understand and rectify the problem of excessive interest spreads which is hurting the financial intermediation process.