Interest spread, the difference between what a bank earns on
its assets and what it pays on its liabilities, has been on an upward
trend during the last few years: during 2005 the average interest spread
of the banking sector has increased by 2.14 percent. An increase in the
interest spread implies that either the depositor or the borrower or
both stand to loose. In the context of developing economies, the lack of
alternate avenues of financial intermediation aggravates the adverse
impact of increase in spread.1 Interest spread also has implications for
the effectiveness of the bank lending channel. For example, with a
commitment to market based monetary policy, the central bank influences
the yield on treasury bills (T. bill hereafter) that in turn affects the
deposit and lending rates.2 The change in these rates influences the
cost of capital that in turn affects the level of consumption and
investment in the economy. If the pass-through of the changes in yield
on T. bill rate to the deposit and lending rates is asymmetric then this
changes the spread, for better or worse, depending upon the nature of
asymmetry. If the increase in spread is due to lower return to
depositors then this discourages savings; alternatively if it is due to
higher charge on loans, investment decisions are affected. In either
case the increase in spread has an adverse bearing upon the
effectiveness of bank lending channel of monetary policy and has
therefore important implications for the economy......
Banking: Interest Spread, Inelastic Deposit Supply, and
Mergers
