Net Interest Margin: Does Ownership Matter?

Net Interest Margin (NIM) or spread is the difference between interest earned and interest expended by a bank divided by its total assets. A competitive banking system is expected to foster greater efficiency which should get reflected in lower NIM. In the Indian banking industry, NIM has come down subsequent to banking sector reforms but the decline has been very slow. However, it is commonly believed that NIM in developing countries is higher than that in developed countries. The reasons could be lack of sufficient competition, higher intermediation costs, and response to changing regulations. To the extent that NIM can be considered as an indicator of bank performance and efficiency, it is very important to study what are the factors that affect NIM. On the other hand, an ongoing debate in the context of industry performance is the relation between ownership and performance. The theoretical literature suggests that private enterprises are more efficient than public enterprises. However, the empirical evidence is mixed in this regard. It is in this context that this paper studies the determinants of NIM in Indian banking and attempts to draw policy implications based on the exercise. The authors use balance sheet data of all Scheduled Commercial Banks (excluding Regional Rural Banks) for the period 1997–98 to 2000–01 and explore, inter alia, the relationship between ownership and performance. Using econometric techniques of panel regression, viz., fixed effects model and random effects model, they find that even after accounting for bank-specific variables indicating health of banks and regulatory requirements, nature of ownership per se matters in determining NIM. Ownership is represented by dummy variables which take a value of one when a bank belongs to a particular ownership group, and zero otherwise. Statistical significance of the coeffi- cients of the dummy variables indicates that ownership may have a significant associa- tion with NIM. The major findings emerging from the regression analysis can be summarized as follows: NIM is not significantly associated with size of banks. Proportion of non-interest income does not have a significant impact on NIM. Proportion of investment in government securities adversely affects NIM. Proportion of advances to the priority sector positively affects NIM. Higher Capital Adequacy Ratio is associated with higher NIM. Higher Non Performing Assets are associated with lower NIM. Nature of ownership is a significant determinant of NIM. Foreign banks have the highest NIM, followed by public, private, and new private banks. Insights emerging from such an analysis can be useful to both bank managers and policy makers. Managers can benefit from knowledge of the ways in which business decisions can affect spreads. It is also useful for the policy makers to be aware of how regulatory and supervisory decisions can affect efficiency in the banking industry, both group-wise as well as across banks.