ON THE DETERMINANTS OF BANK INTEREST MARGINS UNDER CREDIT AND INTEREST-RATE RISKS

This paper explores the determinants of optimal bank interest margins based on a simple firm-theoretical model under multiple sources of unc ertainty and risk aversion. The model demonstrates how cost, regulatio n, credit risk and interest rate risk conditions jointly determine the optimal bank interest margin decision. We find that the bank interest margin is positively related to the bank's market power, to the opera ting costs, to the degree of credit risk, and to the degree of interes t rate risk. An increase in the bank's equity capital has a negative e ffect on the spread when the bank faces little interest rate risk. The effect of rising interbank market rate on the spread is ambiguous and depends on the net position of the bank in the interbank market. Our findings provide alternative explanations for the empirical evidence c oncerning bank spread behavior.