An Assessment of the Effects of Interest Rates on the Performance of Financial Institutions. A Case Study of Stanbic IPS Branch Kampala
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Date
2006-02
Authors
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Kampala International University, College of Economics and Management
Abstract
Using bank data for 80 countries for 1988-95, the authors show that differences in
interest margins and bank profitability reflect various determinants bank
characteristics, macroeconomic conditions, explicit and implicit bank taxes,
regulation of deposit insurance, general financial structure, and several underlying
legal and institutional indicators. Controlling for differences in bank activity,
leverage, and the macroeconomic environment, they find (among other things)
that: I) Banks in countries with a more competitive banking sector--where
banking assets constitute a larger share of GDP--have smaller margins and are less
profitable. The bank concentration ratio also affects bank profitability; larger
banks tend to have higher margins. 2) Well-capitalized banks have higher net
interest margins and are more profitable. This is consistent with the fuct that banks
with higher capital ratios have a lower cost of funding because of lower
prospective bankruptcy costs. 3) Differences in a bank activity mix affect spread
and profitability. Banks with relatively high non- interest -earning assets are less
profitable. Also, banks that rely largely on deposits for their funding are less
profitable, as deposits require more branching and other expenses. Similarly,
variations in overhead and other operating costs are reflected in variations in bank
interest margins, as banks pass their operating costs (including the corporate tax
burden) onto their depositors and lenders. 4) In developing countries, foreign
banks have greater margins and profits than domestic banks. In industrial
countries, the opposite is true. 5) Macroeconomic factors also explain variation in
interest margins. Inflation is associated with higher realized interest margins and
greater profitability. Inflation brings higher costs--more transactions and generally
more extensive branch networks--and also more income from bank float. Bank
income increases more with inflation than bank costs do. 6) There is evidence that
the corporate tax burden is fully passed on to bank customers in poor and rich
countries alike. 7) Legal and institutional differences matter. Indicators of better
contract enforcement, efficiency in the legal system, and lack of corruption are
associated with lower realized interest margins and lower profitability.
Description
A Dissertation Submitted to the School Of Business and Management in the Partial Fulfillment for the Award of Bachelor of Business Administration Degree Of Kampala International University.
Keywords
Interest Rates, Financial Institutions, Stanbic IPS Branch Kampala