Why Have Bank Interest Margins Been so High in Indonesia Since the 1997/1998 Financial Crisis?

Abstract

We investigate the determinants of net interest margins of Indonesian banks after the 1997/1998 financial crisis. Using data for 93 Indonesian banks over the 2001-2009 period, we estimate an econometric model using a pooled regression as well as static and dynamic panel regressions. Our results confirm that the structure of loan portfolios matters in the determination of interest margins. Operating costs, market power, risk aversion and liquidity risk have positive impacts on interest margins, while credit risk and cost to income ratio are negatively associated with margins. Our results also corroborate the loss leader hypothesis on cross-subsidization between traditional interest activities and non-interest activities. State-owned banks set higher interest margins than other banks, while margins are lower for large banks and for foreign banks.