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Using a unique bank-level data set on the Ugandan banking system during 1999-2005, the authors explore the factors behind consistently high interest rate spreads and margins. While foreign banks charge lower interest rate spreads, they do not find a robust and economically significant relationship between privatization, foreign bank entry, market structure, and banking efficiency. Similarly, macroeconomic variables can explain little of the over-time variation in bank spreads. Bank-level characteristics, on the other hand, such as bank size, operating costs, and composition of loan portfolio explain a large proportion of cross-bank, cross-time variation in spreads and margins. However, time-invariant bank-level fixed effects explain the largest part of bank variation in spreads and margins. Further, the authors find tentative evidence that banks targeting the low end of the market incur higher costs and therefore higher margins.

Bank Policy --- Bank Spreads --- Banking System --- Banks and Banking Reform --- Bond --- Debt Markets --- Developing Countries --- Emerging Markets --- Exchange --- Finance and Financial Sector Development --- Financial Literacy --- Foreign Bank --- Foreign Bank Entry --- Foreign Banks --- Interest --- Interest Rate --- Interest Rate Spread --- Interest Rate Spreads --- Lending --- Loan --- Loan Portfolio --- Macroeconomic Variables --- Market --- Market Structure --- Private Sector Development --- Revenue

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Using a unique bank-level data set on the Ugandan banking system during 1999-2005, the authors explore the factors behind consistently high interest rate spreads and margins. While foreign banks charge lower interest rate spreads, they do not find a robust and economically significant relationship between privatization, foreign bank entry, market structure, and banking efficiency. Similarly, macroeconomic variables can explain little of the over-time variation in bank spreads. Bank-level characteristics, on the other hand, such as bank size, operating costs, and composition of loan portfolio explain a large proportion of cross-bank, cross-time variation in spreads and margins. However, time-invariant bank-level fixed effects explain the largest part of bank variation in spreads and margins. Further, the authors find tentative evidence that banks targeting the low end of the market incur higher costs and therefore higher margins.

Bank Policy --- Bank Spreads --- Banking System --- Banks and Banking Reform --- Bond --- Debt Markets --- Developing Countries --- Emerging Markets --- Exchange --- Finance and Financial Sector Development --- Financial Literacy --- Foreign Bank --- Foreign Bank Entry --- Foreign Banks --- Interest --- Interest Rate --- Interest Rate Spread --- Interest Rate Spreads --- Lending --- Loan --- Loan Portfolio --- Macroeconomic Variables --- Market --- Market Structure --- Private Sector Development --- Revenue

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April 2000 - As financial liberalization progressed, the general level of real interest rates increased more in developing countries than it did in industrial countries. Volatility in wholesale interest rates also jumped, often markedly, in most liberalizing countries. Treasury bill rates and bank spreads showed the greatest increase in developing countries, shifting substantial rents from the public sector and from favored borrowers. Financial liberalization was expected to make interest rates and asset prices more volatile, with distributional consequences such as reduced or relocated rents and increased competition in financial services. Honohan examines available data on money market and bank interest rates for evidence of whether these things happened. He shows that as more and more countries liberalized, the level and dynamic behavior of developing-country interest rates converged to industrial-country norms. In the short term, volatility increased in both real and nominal money market interest rates. Treasury bill rates and bank spreads, evidently the most repressed, showed the greatest increase as liberalization progressed - shifting substantial rents from the public sector and from favored borrowers. Whereas quoted bank spreads in industrial countries contracted somewhat in the late 1990s, spreads in developing countries remained much higher, presumably reflecting both market power and the higher risks of lending in the developing world. There was no clear-cut change in mean rates of inflation, monetary depth, or GDP growth. If anything, there was a small average improvement in inflation, but a decline in monetary depth and economic growth, relative to trends in industrial countries. This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to explore optimal policy under financial liberalization. The author may be contacted atphonohan@worldbank.org.

Asset Prices --- Bank Interest Rates --- Bank Lending --- Bank Spreads --- Borrowers --- Currencies and Exchange Rates --- Debt Markets --- Depos Developing Countries --- Developing Country --- Economic Theory and Research --- Emerging Markets --- Finance and Financial Sector Development --- Financial Liberalization --- Financial Literacy --- Insurance and Risk Mitigation --- Interest --- Interest Rate --- Interest Rates --- Lending --- Macroeconomic Management --- Macroeconomics and Economic Growth --- Market Interest Rates --- Money Market --- Private Sector Development --- Real Interest --- Real Interest Rates --- Treasury --- Treasury Bill --- Treasury Bill Rates