Global Competition, Fee Income and Interest Rate Margins of Banks

Abstract

The major thrust and novel feature of our study is the search for and the evidence we provide regarding the impact of global competition on banks’ interest rate margins and profitability. Our panel data approach utilizes the OECD banking data set and IMF statistics. We base our estimation approach on the dealership models of Stoll (1978), Ho and Stoll (1980) and Ho and Saunders (1981). Subsequent studies with a narrow focus on country-restricted monopoly measures (Saunders and Schumacher, 2000) in banking market or on foreign bank entry features (Claessens et al., 2001) ignore the spill-over effects of competition in global financial markets on domestic banking operations. We provide an avenue for competition in global financial markets to exert its influence on the operations of domestic banks in their respective countries by including the ratio of total foreign assets and liabilities to GDP in our model. This variable portrays the openness of the domestic financial system to global competition. Our estimation results suggest that exposure to global competition tends to narrow net interest rate margins and to reduce the rate of return on assets. We also find strong evidence for the expected inverse impact of the fee-to-income ratio on the interest rate margin and on profitability. The fee-to-interest-income ratio serves as a summary measure of competition in wholesale markets, as a reflection of advanced product mix, and as a variable which mirrors diversification benefits. Furthermore, a novel risk measure (volatility of gross income) impacts positively on the return on assets after tax as well as on the net interest margin, regardless of the model specification or the applied estimation techniques while costs show a negative relation to bank performance measures. (JEL G 21, L 11)