Determinants of the spread of bank interests in Bangladesh

The spread between the lending and the deposit rates plays a vital role in accelerating financial sector development of any country. This paper examines the determinants of the interest rate spread in Bangladesh using panel data for the 47scheduledbanks.Annual data for the sample period from 2004 to 2015 have been used to estimate the model.Panel data models are generally estimated using pooled OLS, fixed effects or random effects techniques. The fixed effects model is compared with the pooled OLS estimation. The F-test statistics rejects the null hypothesis of no fixed effect. If the null hypothesis is not rejected this would mean that the least squares dummy variables model are not different from the pooled OLS model. In such a case, bank-specific and period-specific parameters estimate would give us no significant information. In order to distinguish between fixed effects and random effects models the Hausman test was performed. The random-effect model requires the assumptions that individual error components are uncorrelated with each other and with the explanatory variables in the model. The Hausman test fails to reject the null hypothesis of no random effects. Therefore, the model has been estimated using pooled OLS initially and later with Fixed effect method to see the robustness of the results. The empirical results show that the spread is higher if the deposits rates is lower, banks operating cost is higher, market share of deposits is lower, government national savings directorate (NSD) certificate rate and non-performing loans cash reserve requirements (CRR) are higher. However, the results vary among the group of banks. Policy implications of this study would be foreign banks, state owned commercial and specialized banks need to increase deposits rates to lower spread. All banks need to decrease their operating cost. State owned commercial banks and specialized banksneed to lower their classified loans. Finally, Governments NSD certificate rates and the Central Bank's cash reserve requirements are also main drivers of spread. Therefore, government and the central bank need to be careful about these two variables if they want to decrease spread in the banking system in Bangladesh.