Determinants of Bank Interest Margins: Impact of Maturity Transformation

Abstract

This paper explores the extent to which interest risk exposure is priced in bank margins. Our contribution to the literature is twofold: First, we extend the Ho and Saunders (1981) model to capture interest rate risk and expected returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit intermediation fees, but reduce (increase) these charges for loans (deposits) when positive excess holding period returns from long-term exposures are expected. Second, we test the model-derived hypotheses not just for the commonly investigated net interest margin but also for interest income and expense margins separately in a sample encompassing the German universal banking sector between 2000 and 2009. We find that banks price their individual interest rate risk and corresponding expected excess holding period returns via the asset side into the net interest margin. For liabilities, we find interest rate risk exposure only priced by smaller, local banks.

Keywords: term transformation, interest rate risk, optimal loan, deposit intermediation fees

JEL Classification: D21, D22, G21