Ebook Commercial Bank Interest Rate Spreads in Jamaica
The factors that determine the level of commercial bank lending rates are important concerns to policy makers, the banking industry and the public at large. From a policy perspective, lower lending rates are desirable, as they tend to have a positive influence on new and existing investments, improve the competitiveness of Jamaican businesses and contribute to growth and development. These welfare effects would lead to generally higher living standards and financial surpluses. On the other hand, well known studies of developed country markets have shown that profits in the banking industry tend to rise as interest rates increase. The rapid expansion in the local industry since 1990 would also lend itself to the perception that such a relationship would also hold in the Jamaican context. There is little wonder therefore that the interest rates charged by local banks have been a sensitive and recurring policy issue in Jamaica and one which requires an objective examination of all the factors behind the structure of commercial bank interest rates.
Loan rates can be separated into two major components – the interest rate paid to depositors and the rate added on by banks. That difference between the deposit rate and the loan rate is commonly referred to as the spread. The size of banking spreads serves as an indicator of efficiency in the financial sector because it reflects the costs of intermediation that banks incur (including normal profits). Some of these costs and are imposed by the macroeconomic, regulatory and institutional environment in which banks operate while others are attributable to the internal characteristics of the banks themselves. The objectives of this paper are to establish the time path of banking spreads in Jamaica and the main factors influencing their evolution.
There are two broad approaches to examining interest rate spreads – the ex ante approach and the ex post. The ex ante approach uses the rates quoted on loans and on deposits and draws inferences from the difference between them. These are the rates that the public sees and which are easily comparable across institutions. Ex post measures compare the effective rate paid on deposits with the effective rate earned on loans. This accounting information is drawn from the quarterly income and expenditure reports filed by banks and therefore comes after the fact.
The information contained in these two measures of banking spreads is explored in Sections 2 and 3 below. In Section 4, comparisons are made with international benchmarks of spreads, costs and profits. The paper ends with a discussion of the policy implications of these findings and an exploration of the room for change in the internal administration of financial institutions.
Contents
1. Introduction
2. Measuring Interest Rate Spreads
- Published Rates
Effective Rates
3. Benchmarks
- Inter-bank Comparisons
International standards
4. Concluding Remarks
- Policy Issues
Efficiency Issues
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