Determinants of Commercial Bank Interest Rate Margins: Evidence from Jordan

Husni Khrawish, Mohammad Al-Abadi, Maysoon Hejazi

Abstract


This study examines the determinants of bank net interest rate margins within the context of the Jordanian banking industry. The empirical specification focuses on the reported net interest rate margin that is assumed to be a function of two sets of variables that are incorporated, those are namely bank-specific characteristics (internal variables), and macroeconomic factors, which are used to control for the external variables. However, the study model is tested on time series cross-sectional bank level data in the context of Jordan, in which, the basic model of study uses the linear form with the two targeted categories of variables. For testing purposes, panel data analysis is used by employing three alternative models to estimate the parameters of the model i.e., the Pooled Least Squares (OLS) model, the Fixed-Effect Model and the Random Effect Model (REM). The sample used in this study consists of a panel data set for thirteen commercial banks over the period 1992 - 2005.
The results suggest that, with respect to bank-specific characteristics, higher net interest margin tend to be associated with banks that keep less financial leverage and grant more loans. The operation cost proxy shows that banks overhead costs are passed over to clients in the form of high lending rates and/ or lower deposit rates. The capitalization proxy indicates that banks are well-capitalized, reflecting lower bankruptcy costs. Under the loan-to-asset proxy, it seems that banks are able to maintain low levels on non-performing loans, and hence attain higher interest margins. The size factor has a significant impact in enhancing banks performance in order to remain competitive. Erratically, the effect of market share on banks’ margin indicates that Jordanian banks do not exercise market power in setting prices, and banks that are operationally less efficient gain reasonable net interest margin. The macroeconomic variables show no significant impact on banks net interest margins. However, the positive impact of the growth rate variable indicates that movements to deregulation together with technology advances would lead to improvements in the overall banking businesses, causing higher spreads, and hence, higher net interest margins. The result related to the inflation factor suggests that banks tend to profit from inflationary environment by charging higher loan interest rates, and therefore, higher net interest margins.

Keywords


Net interest margin, Financial leverage, Liquidity crisis, Jordan

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