Measurement and Implication of Commercial Banks' Interest Rate Spread in Selected SEACEN Countries

This study examines commercial banks' interest rate spreads between lending and deposit rates. The measurement of the spread is important as many central banks now are publishing the overall average interest rates of the banking systems while authorities aew increasingly requiring banks to disclose more detailed financial information for determining the spread without additional costs. The internediation spread is an outcome of banks' decision on rates, affected by both micro and macro level factors. As a social cost of financial intermediation, the spread is subject to many macro level issues that shape efficiencies in financial sector performance. A certain level of financial sector structural development is required before banks can gear up to perform at a level of efficiency that can be observed in the spread. The spread is a reward for liquidity risk generated by transforming money into loans and also a reward for the selection and monitoring of the right kind of borrowers. It is thus an information premium. The spread also provides sufficient margins for banks to continue operating in the market. To be competitive in the market, banks have to manage and monitor other risks such as market risk, legal risk and so on. Banks must also be able to cover the costs of operation and give good returns for equity holders. In that sense, central banks and Governments can do a lot in terms of improving the environment in which banks operate, by making the economic environment more conducive for efficient risk management. On the other hand, banks tend to grow big and become leveraged. Thus, ensuring the right level of competition in the market place is crucial for achieving a lower social cost of bank intermediation and at the same time providing long run stability of the system as whole. This analysis of the study is based on a pool of data provided by the selected SEACEN member banks. From the analysis, it was observed that where the risk level is high and the financial infrastructure is not efficient, this methodology seems to be a good way of determining the main factors affecting the spread. The study revealed that banks' spreads are influenced by bank specifics, market forces and the regulatory environment. The findings of the study indicate that the factors that increase the spread in the selected SEACEN countries include market concentration and credit risks. However, bigger banks tend to operate with lower spreads due to better managerial efficiency. Reserve requirements are also costly for customers but statutory reserve remuneration appears to mitigate this burden effectively, at least in some countries. Consolidation through mergers and acquisitions can give banks the market power to operate with higher spreads, contributing to long term stability and profitability of banks.