Determinants of Bank Interest Margins in Central and Eastern Europe

Banks’ interest margins are among the most important indicators of the cost of financial intermediation. This paper investigates the determinants of banks’ interest margins in Central and Eastern Europe (CEE). Given the run-up to EU entry and EU membership itself, dynamics in the banking sector in CEE have developed rather differently than in other emerging market economies. We document that, in contrast to the literature, foreign ownership has a positive effect on interest margins, whereas state ownership proves to be irrelevant. Banks’ pricing of loans and deposits, however, is risk-adjusted in CEE – we detect positive risk premia for both interest and credit risk. However, our data provide some evidence for moral hazard behavior. Moreover, the decreasing interest margins in the region during the first half of the current decade seem to be caused by a decrease in operating costs as well as an increase of efficiency levels and rapid financial deepening.

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