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)| false Ho, T., and A. Saunders, 1981, “ The Determinants of Bank Interest Margins: Theory and Empirical Evidence,” The Journal of Financial and Quantitative Analysis, Vol. 16, proceedings of 16th Annual Conference of the Western Financial Association, pp. 581– 600.
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The authors are grateful for comments received by the Barbadian authorities and Jorge Roldos on an earlier draft. They are greatly indebted to Benedict Clements for very helpful discussions and encouragement.
For the purpose of this paper, capital controls are considered part of the monetary policy regime. Without these controls, monetary policy would be ineffective under Barbados’s fixed exchange rate regime.
For the purpose of this section, the CARICOM region comprises all countries for which a Standard & Poor’s credit rating was available in 2003—that is, Bahamas, Barbados, Belize, Grenada, Jamaica, Suriname, and Trinidad and Tobago.
Gelos (2006) argues that greater macroeconomic stability in Latin America would be conducive to lower interest rates. This, in turn, would contribute to a compression of bank spreads.
The correlation coefficient between the level of spreads and financial intermediation is -0.85.
This section focuses on the impact of macroeconomic variables on spreads in a comparative perspective, and therefore excludes microeconomic factors. These factors, captured in the unexplained residual of the regression, are further examined in Section VI.
The credit rating variable is constructed as a linear function of the qualitative measure provided by S&P over the range C to AAA. Its impact on spreads is robust to an alternative specification that discriminates nonlinearly between investment and non-investment grade ratings.
The set of small island economies includes both developing and industrial countries, among the latter Cyprus and Iceland. As such, it is not correlated with the dummy for developing countries.
This result is robust to the specification of the size and level of development in terms of GDP and GDP per capita, respectively.
Figures based on a data set of 199 observations pertaining to 19 banks in Barbados, Jamaica, and Trinidad and Tobago over 1989–2004. The latter were selected because of their similarity with Barbados in terms of location, size, and overall level of development. These countries are also seeking macroeconomic convergence within the context of the CARICOM Single Market and Economy (CSME).
Assessing the effect of the minimum deposit rate is problematic, given that it only exists in Barbados.
The cost of holding unremunerated reserves is proxied by the statutory cash ratio multiplied by the average deposit rate, as it is standard in the literature (Gelos, 2005).
The cost of holding reserves in Barbados is likely to be influenced by the statutory minimum deposit rate. Therefore, the opportunity cost of holding reserves is first regressed on the statutory minimum deposit rate, and the residuals are included in the panel estimation. Changes in the minimum statutory deposit rate account for 80 percent of the variability in the cost of holding unremunerated reserves. Likewise, endogeneity between the average rate paid on deposits and the minimum deposit rate is addressed by regressing the former on the latter, and including only the residuals in the main regression. Similarly, the difference in yields on short-term instruments in Barbados and the United States is regressed on the inflation rate differentials. The unexplained residual is used as a proxy for the cost of capital controls. As the Barbados dollar has been pegged to the U.S. dollar at a constant rate since 1975, we assume the absence of foreign exchange risk. Also, given that the sovereign credit rating on short-term local currency debt for Barbados and the U.S. was the same during the period, namely A-1, it is not necessary to control for country risk premium.
As this section aims to explore the variation of spreads across time, the models used in the analysis exclude the credit rating variable, owing to its persistence over time.
When net interest margins are used as the dependent variable, all explanatory variables turn out to be statistically insignificant, though typically showing the expected signs in their coefficients.
Excluding control variables, monetary variables alone explain 76 percent of the variation in bank spreads.
Given that the cost of reserves is constructed by multiplying the cash ratio by the deposit rate, an increase of 1 percentage point in the cost of reserves requires a substantial increase of either of the two variables.
The correlation between the average deposit rate and the t-bill rate is 0.93 for the sample period.
This finding does not address the potential effect of bank size on profits. One factor driving mergers and acquisitions in the banking sector may be the search for portfolio diversification.
This variable is significant only at the 10 percent confidence level with a coefficient of 0.2.