Determinants of bank net interest margin: does monetary union membership matter?

Abstract

The purpose of this thesis is to carry out an empirical investigation into whether membership of monetary union matter in the determination of bank net interest margin. Bank net interest margin is the difference in bank borrowing and lending rates relative to the total interest-earning assets. We operationalise this study by comparing panels of commercial banks within and outside economic and monetary unions in Europe and Sub-Saharan Africa. For our European analysis we use bank-level data from nine Euro Area countries and seven non-Euro Area economies, in a dynamic empirical model, employing Arellano and Bover (1995)/Blundell and Bond (1998) system GMM estimation method. We find that stronger competition and efficiency, as well as greater macroeconomic stability in the Euro Area reduce bank net interest margins more than in the non-Euro Area. We attribute this to the well-developed single market with a strong socio-economic cohesion underpinning rather than the economic and monetary union. We extend the same level of analysis to the Sub-Saharan Africa, where we contrast our findings in the West African Economic and Monetary Union (WAEMU) with those of twenty non-monetary union Sub-Saharan African economies. Our findings in the Sub-Saharan African context reveal a rather different scenario. While the WAEMU enjoys relatively lower net interest margins than its non-monetary union counterparts, this is attributable to the union’s ability to pursue vigorously its primary objective of maintaining price stability by maintaining lower interest rates. Unlike in the Euro Area we do not observe a reducing impact of bank competition and efficiency on bank net interest margin in the West African Economic and Monetary Union (WAEMU) as we do in the non-monetary union Sub-Saharan Africa. We find these results for the Sub-Saharan African analysis puzzling, and attribute it to the absence of a well-developed single/common market which is supposed to drive competition and efficiency with the effect of reducing net interest margins, as it obtains in the Euro Area. Our conclusion is that it is rather the presence of a well-developed single market that engenders competition and efficiency effects to reduce bank net interest margins rather than membership of a monetary union per se