chapter  5
21 Pages

The impact of market power and funding strategy on bank- interest margins

WithMohammed Amidu, Simon Wolfe

Banks play a key role in financing economic activities in a country. By its very nature, banking is an attempt to manage multiple and seemingly opposing needs. Banks accept deposits and assure savers that their deposits are liquid and secure. They extend credit as well as liquidity to borrowers through lines of credit (Kashyap, Rajan, and Stein 2002). Channelling funds from lenders to borrowers is the primary intermediation function of banks. In order to achieve this greater social welfare, it is important that the intermediation function is carried out with the lowest possible cost. Accordingly, the lower the cost of banks’ interest margins, the lower the social cost of financial intermediation. The effectiveness of a banking system in the intermediation process is often measured by examining the spread between lending and deposit rates, as well as assessing the extent of operational efficiencies of the banking system (Taci and Zampieri 1998). In line with this, the banking literature has concentrated on analysing the determinants of bank interest margins and is pioneered by the seminal paper of Ho and Saunders (1981) and the extensions by McShane and Sharpe (1985), Allen (1988), Angbazo (1997), and Wong (1997).