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Published in:

30-01-2022

Banks’ Net Interest Income from Maturity Transformation and Other Interest Income: Communicating Vessels?

Authors: Raymond F. D. D. Chaudron, Leo de Haan, Marco Hoeberichts

Published in: Journal of Financial Services Research | Issue 1/2023

Abstract

This study investigates the effects of a flattening of the yield curve and decreasing interest rates on the net interest margin (NIM) of 41 Dutch banks during the period 2008Q1 to 2020Q4. Our contribution to the literature is that we distinguish explicitly between net interest income from pure maturity transformation and a residual part representing market power, compensation for risks and other mark-ups. Our results show that the residual part increased when the yield curve flattened and interest rates fell, while total NIM remained constant. In other words, banks managed to keep net interest margins more or less constant by compensating for a loss in income from maturity transformation.

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The speed of adjustment in our model represents the degree to which the bank is able to adjust to achieve its objective, i.e. its target net interest rate margin. In mathematical terms \({y}_{it}={y}_{it-1}+\theta \left({y}_{it}^{*}-{y}_{it-1}\right)\), where y is the actual net interest rate margin and y* is the target. This allows the model to account for serial correlation in the dependent variable.

Busch and Memmel (2016) also decompose the NIM but use a different approach. They model the separate components of the NIM econometrically.

See footnote 19 on page 9 in Entrop et al. (2015): “… in our setting we prefer the single-step approach as it allows the revolving portfolios and the variables proxying for the interest risk in the intermediation fees to be correlated.”

Others, such as Bikker et al. (2012) and Coccorese (2014), use variables such as fixed or non-financial assets to scale capital costs. A number of banks in our sample have no fixed or non-financial assets but rent or lease their premises. For this reason, we scale capital costs by total assets, in line with Angelini and Cetorelli (2003) and Ariss (2010).

Measuring competition is not trivial and alternative measures based on Price Cost Margins or Profit Elasticity have advantages (see Boone et al. 2013). As mentioned above with the Lerner-index, these alternative measures may be considered problematic when they are used to explain margins.

We also included a market share of deposits but it turned out to be highly collinear with the market share of loans. We therefore only use the market share of loans.

An earlier specification also included a Boone indicator (see Boone 2008). It turned out that the Boone indicator is highly correlated with the one year interest rate. While this might be purely accidental, we decided to exclude the Boone indicator from our estimations since we are mainly interested in the effects of low interest rates on margins.

We also estimated a specification with dummies for the year 2020, to account for the onset of the COVID pandemic. The errors were too large to give any significant results. The outcomes are available from the authors upon request.

Unreported results available from the authors upon request.

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Title: Banks’ Net Interest Income from Maturity Transformation and Other Interest Income: Communicating Vessels?
Authors: Raymond F. D. D. Chaudron
Leo de Haan
Marco Hoeberichts
Publication date: 30-01-2022
Publisher: Springer US
Published in: Journal of Financial Services Research / Issue 1/2023
Print ISSN: 0920-8550
Electronic ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-021-00375-8