THE BEHAVIOR OF BANK NET INTEREST MARGIN1

THE BEHAVIOR OF BANK NET INTEREST MARGIN IN JORDAN:

THE IMPACT OF INTEREST RATE LIBERALIZATION AND TAX

REDUCTION

By

Jamileh “Mohammad Walid” Izzat “Ali Moustafa”

Supervisor

Dr. Ghassan Omet, Prof.

This thesis was submitted in partial fulfillment of the requirements for

the Master's Degree in Finance

Faculty of Graduate Studies

The University of Jordan

April,2015

COMMITTEE DECISION

This thesis “The Behavior of Bank Net Interest Margin in Jordan: The impact of interest

Rate Liberalization and Tax Reduction” was approved on 29/4 / 2015.

Examination CommitteeSignature

Dr. Ghassan Omet (Supervisor) ……………….

Prof. of Finance

Dr. Diana Abu-Ghunmi (Member) ……………….

Assistant Professor of Finance

Dr. Adel Bino (Member) ……………….

Assistant Professor of Finance

Dr. Adel Sharkas (Member) ……………….

Associate Prof. of Finance

Deputy Governor / The Central Bank of Jordan

iii

DEDICATION

To My Parents

My sisters

My brothers

And my friends

iv

ACKNOWLEDGMENTS

I wish to express sincere gratitude to my supervisor Prof.Ghassan Omet for guidance,

valuable advice, support, and assistance in finding data. I am also grateful to all research

workshop professors for their useful comments. Finally, special thanks to my parents and

my friends for their moral support.

v

TABLE OF CONTENTS

Subject Page

Committee Decision ……………………………………………..…………………. ii

Dedication ……………………………………………............................. …. …….. iii

Acknowledgment…………………………………………….. …… ……………... . iv

List of Contents……………………………………………….......... …………….... v

List of Tables……………………………………………………………………....... vi

Abstract ………………………………………………………................................... vii

Chapter One: INTRODUCTION………..…………………....................................... 1

1.1 Introduction……………………………………………………............................ 2

1.2 Research Problem ……………………………………………… ……………….. 4

1.3 Research Importance………………………………………………………………. 5

1.4 Research Objective ……………………………………………………………….. 5

Chapter Two: LITERATURE REVIEW..…. ………………….................................... 6

2.1 Overview of Jordanian Banking Sector………………………... …......................... 7

2.2 Bank Net Interest Margin …………………………………. .................................. 10

Chapter Three: DATA, METHODOLOGY AND

EMPIRICAL RESULTS…………………………………………... ………………... 13

3.1 Introduction……………………………………………………. ………………... 14

3.2 Research Theoretical Framework…………………………………………........... 15

3.3 Descriptive Statistics……………………………………………………….....….. 15

3.4 The Econometric Approach…………………………………… ………………… 19

3.5 Research Hypotheses………………………………………………………........... 20

3.6 Empirical results and Discussion…………………………………………… ….... 21

Chapter Four: CONCLUTIONS AND RECOMMENDATIONS…………………….. 28

References…………………………………………………………............................... 31

Appendices……………………………………………………….................................. 33

Abstract (in the second language)…………………………………............................... 34

vi

LIST OF TABLES

Table Page

1. Banks In Jordan 8

2.Cumulative Data of Jordanian Banks 9

3.Descriptive Statistics 16

4. Descriptive Statistics 17

5. Descriptive Statistics 18

6.Regression Results 22

7. Regression Results 23



10. Sample Banks 33

vii

THE BEHAVIOR OFBANK NET INTEREST MARGIN IN

JORDAN: THEIMPACTOF INTEREST RATE LIBERALIZATION

AND TAX REDUCTION

By

Jamileh “Mohammad Walid” Izzat “Ali Moustafa”

Supervisor

Dr. Ghassan Omet, Prof.

ABSTRACT

The effectiveness of the banking system in channeling funds from surplus to deficit units

is often gauged by examining the net interest margin. In this regard, it is interesting to

note that since the early 1980s, the Jordanian banking sector has witnessed two major

changes in laws and regulations. These are the 1989 interest rate liberalizationand the

1996 tax rate reduction in the corporate tax from 55% to 35%. This study investigates the

potential impact of these important changes in the behaviour of bank net interest margin,

within the context of the Jordanian banking industry over the period 1982-2013. It

assesses to what the extent the relatively high and escalating bank interest margins, in this

sector can be attributed to low efficiency or non competitive market conditions,

controlling for the bank specific and macroeconomic environment factors. Based on a

sample consist of 12 banks operating in Jordan over the study period, the results indicate

that bank interest margins have remained relatively high and rapidly increasing over time.

Chapter One:

INTRODUCTION

2

1.1 Introduction

Following the classical arguments by Schumpeter (1934) and Robinson (1952) about the role of

financial systems in economic growth, a large number of papers have examined this issue.

Indeed, this literature has coined the term “financial development”.

To compare countries in terms of financial development, one must be able to rank them in terms

of the impact of each country’s financial system on, for example, the efficiency of the allocation

of resources, and on monitoring managers. Naturally, such an exercise is ideal and difficult to do.

As a major part of any financial system, and the fact that financial intermediaries (banks) are

economically important, one should not be surprised that the financial economics literature

contains many papers which examine the performance of banks in terms of various issues,

including the determinants of net interest margin, determinants of accounting performance,

impact of foreign banks on the performance of local banks, determinants of bank credit,

determinants of bank capital, and others. Moreover, bank interest margins can have major

economic implications. For example, it can be argued that wide interest margins push up the cost

of capital, thereby reducing feasible capital investment opportunities. Similarly, wide margins can

signify the existence of problems (inefficiency and moral hazard) in the banking industry. Given

these arguments, many studies examined the performance of the banking industry in terms of net

interest margins and their determinants.

In reality banks’ net interest rate margins (NIM) represent a vital component of profitability and

typified a summary measure of bank net interest return of which interest margin reflects both the

3

volume and mix of a banks’ assets and liabilities, and covers the cost of intermediation function.

Thus, a wide deposit-lending interest rate spread could be indicative of banking sector

inefficiency or a reflection of the level of financial development (Folawewol and Tennant 2008).

Embedded in the spread is the information on the efficiency of financial intermediation,

profitability, monetary policy impact, among others.

Relative to the above, it is interesting to note that since the 1980s the Jordanian banking sector

has witnessed two major changes in laws and regulations. These are the 1989 interest rate

liberalization and the 1996 tax reduction in the corporate tax from 55 percent to 35 percent.

A large body of literature exists on the potential impact that interest rate liberalization has had on

uncovered interest rate parity. However, it can also have important effects on domestic bank

spreads by providing economies of scale and scope and increasing competitive pressures. One of

the expected benefits of financial liberalization and deepening of the financial sector is the

narrowing of the interest rate spreads– the difference between the interest rate charged to

borrowers and the rate paid to depositors. This is predicated given the understanding that

liberalization enhances competition and efficiency in the financial sector.

Despite the liberalization of the financial sector, high interest rate margins are still an issue of

concern in a number of countries, including Jordan. The empirical results show that bank-specific

factors play a significant role in the determination of interest rate margins. These include bank

size based on bank assets, credit risk as measured by non-performing loans to total loans ratio,

liquidity risk, return on average assets and operating costs. The impact of macroeconomic factors

4

such as real economic growth and inflation is not significant. Similarly, the impact of policy rate

as an indicator of monetary policy is found to be positive but weak. On average, big banks have

higher margins compared to small banks. There is need for explore policy options meant to

enhance competition in the industry and measures to break market dominance will be one such

option. Further, the banking sector needs to explore internal as well as industry-driven strategies

that counter some of the bank-specific factors associated with higher spreads. These could range

from diversification of products to investment in cost-saving and efficient forms of technology.

This thesis attempts to measure the impact (if any) of the above-mentioned changes (interest rate

liberalization and tax reduction) on the Jordanian banking sector in terms of net interest margin.

The result indicates that the 1989 interest rate liberalization had no impact on bank net interest

margin, while the 1996 corporate tax rate reduction, reduced bank net interest margin, but net

interest margins remained relatively high and increasing over time.

1.2 Research Problem

This thesis examines the issue of net interest margin in the Jordanian banking sector spans over

the period 1982-2013.The main research questions are as follows:

Did the 1989 interest rate liberalization have any significant impact on net interest margins?

Did the 1996 income tax reduction have any significant impact on net interest margins?

5

1.3 ResearchImportance

The fact that net interest margin is one known measure of bank efficiency, it is important to

measure it in the Jordanian banking sector and. In addition, it is also important to learn from the

experience of the 1989 interest rate liberalization and the 1996 tax reduction in terms of their

impact on this measure. Indeed such experience should be useful not only in understanding what

really determines bank’s net interest margin , but also in guiding the government in any future

changes in corporate tax policy.

1.4 Research Objectives

This thesis has three main objectives. These are briefly outlined below:

A- To measure net interest margin that exist in the Jordanian banking sector.

B- To investigate whether or not the 1989 interest rate liberalization had any significant impact

on net interest margins.

C- To investigate whether or not the 1996 income tax reduction had any significant impact on net

interest margins?

Chapter Two:

LITERATURE REVIEW

7

2.1Overview of Jordanian Banking Sector

The banking sector in Jordan –as in many countries –is considered one of the main pillars of the

Jordanian economy. In spite the difficult events that have taking place since the beginning of the

year 2011 following the Arab spring, the Jordanian banking sector of 26 banks, 15 listed on

Amman Stock Exchange (ASE) witnessed a healthy activity growth during the year 2013, with

total assets growing of 9% yearly in 2013 to reach JD 54,912,998,990 at the end of December

2013, and proving more than twice higher than that recorded during the last year.

The primary source of income of Jordanian banks arises from interest income and commissions

paid out on deposits and loans. Since the beginning of the 2013, all banks reported growth in their

interest income. The banks featured of high liquidity, invested sufficient portion in claims on the

public sector, specifically in government securities, and adequately capitalized to face potential

pressure on funds.

Total deposits the main activity driver of banks in Jordan , accounting to two thirds of total

balance sheets at end-December 2013.total deposits progressed by 11%on a yearly basis to reach

JD 35,544,453,854 at year –end 2013,and this is four times higher than that registered during

2012.

8

Table 1. BanksIn Jordan

Bank Name Ticker Origin Type

Arab Bank ARAB National Commercial

Arab Banking Corporation ABCO National Commercial

Arab Jordan Investment Bank AJIB National Commercial

Bank Al-Etihad UBSI National Commercial

Bank Of Jordan BOJX National Commercial

Cairo Amman Bank CABK National Commercial

Capital Bank Of Jordan EXFB National Commercial

Invest Bank INVB National Commercial

Jordan Ahli Bank AHLI National Commercial

Jordan Commercial Bank JCBK National Commercial

Jordan Kuwait Bank JOKB National Commercial

Societe General De Banque Jordanie SGBJ National Commercial

The Housing Bank For Trade And Finance THBK National Commercial

Jordan Islamic Bank JOIB National Islamic

Jordan Dubai Islamic Bank JDIB Foreign Islamic Islamic International Arab Bank Not listed Foreign Islamic

Banque Audi Not listed Foreign Commercial

Blom Bank Not listed Foreign Commercial

City Bank Not listed Foreign Commercial

Egyptian Arab Land Bank Not listed Foreign Commercial

HSBC Not listed Foreign Commercial

National Bank Of Abu-Dhabi Not listed Foreign Commercial

National Bank Of Kuwait Not listed Foreign Commercial

Rafidian Bank Not listed Foreign Commercial

Standard Chartered Not listed Foreign Commercial

Al-Rajhi Bank Not listed Foreign Islamic

The largest consistent of the consolidated assets of Jordanian banks is credit facilities granted. At

the end of 2013, the total credit facilities granted amounted to JD 24,341,154,121.Up from JD

23,367,007,166 the prior year. While banks boasted higher deposits during 2013,lending

activities grew more or less satisfactory but fell short of that during last year. The credit facilities

from a currency aspect show that local currency lending contributed to two thirds of the total

lending of the Jordanian banking sector, while those in foreign currencies were responsible for

the remaining third.

9

It’s worth pointing out that there is an increase in the lending activity of Jordanian Banks in 2013

by 7%, its almost to the benefit of the resident private sector, but fell short of that during the

previous year. the rise in total credit facilities was mostly owed to higher lending to the

construction sector, followed by lending to general trade, industry and mining sectors, among

others.

Table 2. Cumulative Data of Jordanian Banks in JD 2010 2011 2012 2013

Net interest income 1,233,204,022 1,291,294,892 1,435,729,365 1,557,317,208

Net commission income 294,550,850 314,925,918 335,242,194 336,611,855

Total assts 48,477,966,019 50,516,950,642 52,024,825,201 54,912,998,990

Customers Deposits 30,882,139,663 32,564,590,886 33,375,933,379 35,544,453,854

Banks & Financial Institutions

Deposits 4,789,628,894 4,769,802,734 4,567,019,027 4,025,788,906

Direct credit facilities 21408,367,027 22,020,352,390 23,367,007,166 24,341,154,121

Paid In Capital 2,099,314,955 2,231,229,558 2,359,442,179 2,406,100,000

10

2.2Bank Net Interest Margin

Many developing countries have adopted financial liberalization measures in order to make their

banking systems more efficient. However, despite this measure, bank net interest margins have

remained wide. Several arguments have been advanced to this behavior. These include

monopolistic behavior (Barajas et al., 2000), absence of bank deposit insurance, high reserve

requirements (Saunders and Schumacher, 2000), high non-financial (operating) costs and

macroeconomic instability in terms of inflation (Brock and Rojas-Suarez, 2000).

As mentioned above, many papers examine the determinants of bank net interest margin. These

papers include Brock and Rojas-Suarez (2000), Moore and Craigwell (2002), Drakos (2003),

Chirwa and Mlachila(2004), Doliente (2005), Valverde and Fernandez (2007), Hawtrey and

Liang (2008), Claeys and Vennet (2008), Beck and Hesse (2009), Marinkovic and Radovic

(2010), Maudos and Solis (2009), Oreiro and de Paula (2010), Perera et al. (2010), Souza-

Sobrinho (2013).

The above-mentioned research papers estimate a version of the following model:

Yi,t = αi + Xitβ +εi,t i = 1,..., n, t = 1, ..., T (1)

Where

Yi, t is net interest margin (interest income minus interest expense divided by total assets) of bank

i at time t, while Xit represents the vector of k explanatory variables, and is the disturbance term.

Some of the explanatory variables include bank size, ratio of personnel expenses to total assets,

11

ratio of interest expenses to total deposits, ratio of other operating expenses to total assets, ratio of

equity capital to total assets, net loans to total assets, real GDP growth rate, and others.

Barjas et al. (1999) examine the source of high intermediation spreads observed in the Colombian

banking sector over the pre-liberalization period (1974-1988)and the post liberalization period

(1991-1996)found mix results, liberalization increased banking sector competitiveness, lower

market power, and reduced financial taxation from its 1970s level.

Relative to the literature which examines the determinants of net interest margin, it is useful to

note that the classical paper by Demirguc-Kunt and Huizinga (1999) investigated the

determinants of bank interest margins (spread) using bank-level data for 80 countries. The set of

regresses (independent variables) that they used include variables that account for bank

characteristics, macroeconomic conditions, bank taxation and underlying legal and institutional

indicators.

Based on their empirical results, they report that the ratios of equity to total assets and loans to

total assets impact bank interest margins positively. Similarly, it is found that overhead costs and

inflation lead to an increase in interest margins.

As far as Arab banks are concerned, Ben Naceur and Goais (2001) and Ben Naceur (2003), Ben-

Khedhiri et al. (2005) and Mensi (2010), Ben-Khediri and Ben-Khediri (2011) examined the

Tunisian banking sector in terms of its net interest margin and the results indicate that “bank-

specific variables and regulatory changes are the most relevant factors in explaining Tunisian

12

banks interest differential. Finally, macroeconomic variables do not seem to influence bank

margins” (Ben-Khedhiri et al., 2005). Similarly, Lebanese banks have been examined by Hamadi

and Awdeh (2012).

Chapter Three:

DATA, METHODOLOGY AND EMPIRICAL RESULTS

14

3.1 Introduction

This study examines the impact of interest rate liberalization and tax reduction on the behavior of

bank’s net interest margins within the context of the Jordanian banking industry.

To carry out the analysis, the researchers managed to collect the annual data for a total of 12

banks during the period 1982-2013. This sample is based on the availability of the adequate

information. However, due to missing observations for some banks,a restricted sample covering

12 banks over the same period is employed.

The data base is compiled from the financial statements of banks. The names of the banks

included in the data base are given in the appendix. The Macroeconomic indicators are taken

from Central bank of Jordan. The main banks indicators provided in the data base are:

The natural logarithm of total assets (SIZE),Total operating expenses to total assets (OVERH),

Equity capital to total assets (CAP),Total credit (loans) to total assets (LOANS), andNet

commission income to total assets (COMM).

As well as macroeconomic indicators which included are: Real GDP growth rate

(GROWTH),Inflation rate (INF).Both descriptive statistics and regression analysis are

undertaken.

15

3.2 Research Theoretical Framework

The dependent and independent variables used in this thesis are defined as follows:

The Dependent Variable:

Net Interest Margin: [Interest Income – Interest Expense] / Total Assets

The Independent Variables:

The natural logarithm of total assets (SIZE)

Total operating expenses to total assets (OVERH)

Equity capital to total assets (CAP)

Total credit (loans) to total assets (LOANS)

Dummy variables for the 1989 interest rate liberalization and the 1996 tax reduction

Net commission income to total assets(COMM)

Real GDP growth rate (GROWTH)

Inflation rate (INF).

3.3Descriptive Statistics

The descriptive statistics for the data base are provided in table3 and 4. Based on the reported

figures, one can see that the average net interest rate margin over the sample period was equal to

2.32% about 0.07% points lower than the median margin.

16

There is a fair bit of variation in the margin across banks, with the highest margin for the banking

system 5.91%,reported for the Arab bank in 1995. In contrast,the lowest net interest margin was

equal to 0.02% reported again by the Arab bank in 1999.

To provide further analysis table 3 calculates the sample means, the results.

Table 3. Descriptive Statistics

Mean Median Maximum Minimum SD Observations

NIM .023207 .023927 .059058 .000229 .010631 384

SIZE 19.83517 19.71553 23.9235 15.88212 1.631237 384

OVERH .042573 .034843 .136045 0 .026781 384

CAP .076494 .055055 .394241 .00349 .067840 384

LOANS .441848 .433076 .739034 .188723 .110118 384

COMM .008506 .007729 .065707 .000994 .006083 384

INF .049079 .0352 .2571 -.0068 .050636 384

GROWTH .044023 .042 .187 -.135 .046251 384

DUMLIB .710938 1 1 0 .453918 384

DUM TAX .5 .5 1 0 .500652 384

17


year Mean

NIM

Mean

SIZE

Mean

OVERH

Mean

CAP

Mean

LOANS

Mean

COMM

Mean

INF

Mean

GROWTH

1982 .027 18.029 .07151 .0961 .5227 .8337 .0723 .0695

1983 .025 18.162 .07304 .0875 .5055 .6183 .0502 .02

1984 .025 18.298 .07072 .0786 .5157 .5533 .0385 .086

1985 .019 18.401 .06802 .0737 .5022 .4623 .0298 .035

1986 .019 18.525 .06806 .0655 .4983 .4989 0 .07

1987 .019 18.618 .06691 .0652 .4984 .4904 -.002 .029

1988 .019 18.747 .06674 .0600 .5032 .7406 .0661 -.019

1989 .019 18.860 .06093 .0582 .4251 .4528 .2389 -.1166

1990 .024 18.871 .06427 .0561 .4548 .0851 .1509 .01208

1991 .027 19.137 .05229 .0415 .3894 .1300 .0748 .02233

1992 .024 19.320 .04748 .0409 .3949 .2162 .0364 .1738

1993 .028 19.401 .04789 .0431 .4351 .4813 .0359 .0406

1994 .029 19.528 .04389 .0511 .4568 .4077 .0352 .05

1995 .029 19.561 .04368 .0576 .4901 .4077 .0235 .062

1996 .029 19.648 .04221 .0561 .5059 .4215 .065 .021

1997 .020 19.772 .04089 .0659 .4863 .3991 .0304 .033

1998 .023 19.827 .04064 .0699 .5212 .3680 .0309 .03

1999 .024 19.934 .03749 .0643 .4855 .3012 .0061 .034

2000 .022 20.179 .03134 .0834 .3675 .2623 .0067 .042

2001 .024 20.253 .03238 .0832 .3852 .2047 .0177 .053

2002 .023 20.260 .03442 .0894 .3639 .2098 .0183 .058

2003 .025 20.247 .03454 .0889 .3719 .2089 .0163 .042

2004 .023 20.454 .02696 .1125 .3807 .1754 .0336 .086

2005 .026 20.705 .02380 .1020 .4183 .1288 .0349 .081

2006 .029 20.858 .02041 .0848 .4580 .1585 .0625 .081

2007 .028 21.002 .02311 .0884 .4582 .1761 .0539 .082

2008 .032 21.081 .02340 .0904 .4893 .1912 .1493 .072

2009 .029 21.166 .02447 .0896 .4523 .1855 -.007 .055

2010 .032 21.240 .02482 .0873 .4505 .1598 .0501 .023

2011 .030 21.281 .02814 .1129 .4630 .1426 .0441 .026

2012 .031 21.352 .02722 .1076 .4739 .1403 .048 .027

2013 .028 21.455 .02158 .1025 .4523 .1271 .059 .028

To provide further analysis of the trends in the two indicators, Table5 calculates the sample

means of net interest margins for the 12 banks grouping as well as for year intervals:1982 to 1989

, 1982to 1996,1990to1995,and 1997 to 2013. The means are also reported for each group,as well

as the entire sample period for a comparison purposes.

18

The results provided in Table 5 indicate that when interest rate liberalization applied was adopted

in 1990, the average NIM was equal to 2.4% with 0.5% higher than average of 1989, and lower

than the average NIM for the period over 1982-1989 by .2%.

In addition, in 1997 the average NIM was equal to 2% which is a decrease by 0.9% in response to

tax reduction than the average NIM during the 1996,and lower by 0.96% lower than the period

1982-1996.

To find the impact of tax reduction after liberalization the average NIM of 2.71% for the period

1990-1996 indicate that average NIM decreased by .02%.


Year interval 1982-2013 1982-1989 1982-1996 1990-1996 1996-2013

NIM MEAN .023207 .026184 0.0295 0.0271 .0247

DUM LIB

MEAN

.711 0 .462 1 1

DUM

TAXMEAN

.5 0 0 0 1

While these changes interest rate policies and tax rate have been significant,to a large degree, this

has not been reflected in a significant reduction in net interest margins. Indeed Table 5 suggests

that interest rate margins have risen in Jordanian banks in the period after 1996.

19

3.4 The Econometric Approach

The previous results present only a cursory analysis of the relationship between net interest rate

margins,interest rate liberalization and tax reduction. There are a number of other factors that

may impact on interest rate margins. To effectively take account these factors, the panel data

model is estimated that utilizes both the time-series and cross- sectional dimensions of the data

base by using thefixed effect model. Practically, this is the preferred estimationsince the

Hausman specification test rejects the random effects model.

The regression model therefore is estimated as follow:

NIMi,t = α0 + β1SIZEi,t + β2OVERHi,t + β3CAPi,t + β4LOANSi,t + β5COMMi,t+ β6GROWTHt+

β7INF,t+ β8DUMi,t+ εi,t

Where i denotes the bank and t denotes the time period.

NIMi, t: the net interest rate margin

SIZE: is the natural logarithm of total assets.

OVERH: is a total operating expense to total assets.

CAP: is equity capital to total assets.

LOANS: is total credit (loans) to total assets.

COMM is net commission income to total assets.

GROWTH is real GDP growth rate.

INF is the inflation rate.

DUM is a liberalization dummy variable which is equal to 1 for the period 1982-1990 and 0

otherwise. Also, a dummy variable tax is (1) for the period 1982-1996 and0 otherwise.

20

It is necessary to note here that the regression model used treating the data as pooled observations

and therefore,assumes that the residual are not correlated either across different time periods or

cross different banks during the same or different time periods.(i.e. Observations are

homoskedastic and not serially correlated).

3.5Research Hypotheses

Main Hypotheses:

H0: The 1989 interest rate liberalization has had no impact on bank net interest margin.

H0: The 1996 tax reduction has had no impact on bank net interest margin.

Secondary-Hypotheses:

H0(1): Larger banks do not have narrower net interest margin.

H0(2): Banks with greater operating expenses do not have narrower net interest margin.

H0(3): Banks with stronger equity base do not have narrower margin.

H0(4): Banks with high liquidity do not have wider margin.

H0(5): More diversified banks tend to have worse performance.

H0(6): Economic growth does not positively impact net interest margin.

H0(7): Inflation rate does not positively impact net interest margin.

21

3.6 Empirical results and Discussion

This section of the study provides the estimation results for equation to identify whether the

results obtained are sensitive to the estimation approach employed.

Basic regression results:

To estimate the relationship between the variables and NIM, and for further analysis for the

impact of interest rate liberalization and tax reduction on bank’s net interest margins adopted two

regression models, Table 6 ,7,8 and 9 reports the results of two sets of regression models of the

determinants of the net interest margin .

The first model includes bank-specific variables.

The second model drops all bank-specific and macroeconomic variables. Consider significant

variables at level 5% or less, and other wise insignificant. Overall, the estimation results come as

follow:

1-The impact of interest rate liberalization:

To estimate the impact of 1989 interest rate liberalization on bank’s net interest margin, Table 6

reportsthe results of regressing the net interest margin on its’ various determinants for the banks

under study ,and regression results of NIM with all bank-specific and macroeconomic variables,

including the dummy variable of net interest liberalization during the period 1982-2013.

22

Table 6. Regression Results (1982-2013)

The estimation results indicate that the coefficient of interest rate liberalization is negative but not

statistically significant, in both regression models. While three bank specific variables: total assets,

equity capital, and commission income was highly significant with appositive relationship with bank

net interest margin.

To ensure our results , we lagged dependent variable ,the bank net interest margin ,as well as

five banking industry specific variables : Bank assets, overhead expenses , capital equity , total

credits and commission income in addition to macro economic variables . the regression results

show same result except that Real growth of GDP have a significant impact on NIM with a

Variable Coefficient t-Statistic Probability Variable Coefficient t-Statistic Probability

α -.076112 -4.602242 0 α -0.076965 -5.105007 0

SIZE .004131 4.851882 0 SIZE .004197 5.232554 0

OVERH .046324 .758086 .4489 OVERH .046136 .763981 .4454

CAP .071612 5.647282 0 CAP .071485 5.61438 0

LOANS .01487 1.33055 .1842 LOANS .014705 1.316902 .1887

COMM .400084 4.06391 .0001 COMM .401104 4.080526 .0001

DUM

LIB

-.000061 -.038805 .9691 DUM LIB -.000724 .050288 .9599

Effect specification

R-squared : .567249

Adjusted R-squared: .5477149

F-statistic : 28.22075

Durbin-Watson stat : 1.005506

INF -.004175 -.488591 .6254

GROWTH .000724 .050288 .9599

Effect specification R-squared : .56766 Adjusted R-squared: .545093 F-statistic : 25.15419 Durbin-Watson stat : 1.31501

23

coefficient of 1.7% and positive relationship, and that support the primary hypothesis that the

1989 interest rate liberalization has had no impact on bank net interest margin.

The estimation results summarize in table seven as follow:


2- The impact of tax reduction:

To estimate the impact of 1996 Tax rate reduction in the corporate tax from 55% to 35% on

bank’s net interest margin, table 8 reports the results of regressing the net interest margin on its

various determinants, for the banks under study ,and regression results of NIM with all bank-

specific and macroeconomic variables, including the dummy variable of Tax during the period

1982-2013.


α -.069641 -4.490798 0 α -.074705 -4.384682 0

SIZE(-1) .003933 5.234112 0 SIZE(-1) .004251 4.91989 0

OVERH(-1) .026973 .523273 .6011 OVERH(-1) .027908 .543053 .5874

CAP(-1) .081059 5.994566 0 CAP(-1) .080446 5.952444 0

LOANS(-1) .003933 5.234112 0 LOANS(-1) .007872 .922141 .3571

COMM(-1) .358744 3.206811 .0015 COMM(-1) .357881 3.451215 .0006

DUM LIB(-

1)

.00063 .350996 .7258 DUM LIB(-

1)

-.000802 -.461885 .6444


R-squared : .598628




INF(-1) -.006893 -.760722 .4473

GROWTH

(-1)

.017007 2.647004 .0085


R-squared : .606569




24


The estimation results indicate that the coefficient of Tax reduction is positive and statistically

significant , in both regression models. In addition to the three bank specific variables: total

assets, equity capital, and commission income, also highly significant with appositive

relationship with bank net interest margin.

To ensure our results , we lagged dependent variable ,the bank net interest margin ,as well as

five banking industry specific variables: Bank assets, overhead expenses, capital equity , total

credits and commission income in addition to macro economic variables . the regression results

show same result except that In addition to tax and three bank variables, Real growth of GDP

have a significant impact on NIM with a coefficient of 1.8% and positive relationship. The

estimation results summarize in table seven as follows:


α -.050255 -2.7008882 .0072 α -.050247 -2.714664 .007

SIZE .002729 3.083287 .0022 SIZE .002723 3.004232 .0028

OVERH .051476 .83777 .4027 OVERH .051831 .865209 .3875

CAP .065241 4.939674 0 CAP .065201 4.939386 0

LOANS .015818 1.526365 .1278 LOANS .015787 1.525235 .1281

COMM .379932 3.985752 .0001 COMM .379419 3.92113 .0001

DUM

TAX

.003862 2.480738 .0136 DUM TAX .003877 2.569036 .0106


R-squared : .576739



Durbin-Watson stat : .997321

INF .000836 .094699 .9246

GROWTH .00147 .118813 .9055


R-squared : .576768



Durbin-Watson stat : .99948

25


3.The bank-specific characteristics:

- (OVERH):

For the total operating expense to total asset (OVERH) ratio, considering the eight sets of

regression model, the overall result implies that the relationship between overhead –to-asset ratio

and bank’s net interest margin within the Jordanian context is positive, but statically not

significant.In principal the higher the overhead cost in the banking sector the larger the required

spreads to compensate the additional costs. The Jordanian commercial banks would have the

chance to pass overhead cost to their clients by charging higher interest rate on loans or pay lower

interest rates on deposits.


α -.057845 -3.51861 .0005 α -.059651 -3.412197 .0007

SIZE(-1) .003328 4.525129 0 SIZE(-1) .003392 4.163886 0

OVERH(-1) .027209 .53236 .5948 OVERH(-1) .032745 .62315 .5336

CAP(-1) .077596 5.913273 0 CAP(-1) .077313 5.879535 0

LOANS(-1) .00916 1.112815 .2665 LOANS(-1) .00902 1.09824 .2729

COMM(-1) .347651 3.085808 .0022 COMM(-1) .347795 3.34652 .0009

DUMTAX(

-1)

.002094 2.024391 .0437 DUMTAX(

-1)

.001798 1.784079 .0353


R-squared : .601255




INF(-1) .004053 -.417138 .6768

GROWTH

(-1)

.016526 2.927741 .0036


R-squared : .608259




26

- (CAP):

The equity capital to total assets ratio (CAP), which proxies the risk aversion degree of the bank ,

considering the eight sets of regression model , shows as highly significant and a positive

impact in its relationship with the bank net interest margin .such conclusion is in line with

previous evidences i.e., Berger (1995) and Dermerguc-kunt and Huizingua (1999). In general ,the

finding indicate that well-capitalized banks in the Jordanian banking sector support lower

expected bankruptcy cost for themselves and their client, which reduce their cost of capital ,and

lower profit variability.

- (LOANS):

Total credit (loans)to total assets ratio(LOANS) considering the eight sets of regression model,

hasn’t the expected impact on the bank’s net interest margin, since the coefficient of this ratio is

positive but not significant across all specifications ,reflecting less care monitoring acts made by

banks to ward their lending process. under these conclusion there is no chance that banks seek

growth by relaxing credit selection and monitoring. However, that banks seems to be able to

maintain higher levels of nonperforming loans , thereby less profits and margins. This finding

implies also that gaining more loans (increasing market share)would likely to increase the interest

margin.

27

- (SIZE):

The result shows that the relationship considering the eight sets of regression model, between the

size and bank’s net interest margin is positive and highly significant. this finding suggest that

larger banks tend to gain higher margins ,that is, the Jordanian banks operating at significant scale

of economies,(Balloul,2004).overall ,the size proxy result confirms that little cost saving can be

achieved by increasing the size of the banking firm(Berger et al.,1987).yet significant scale of

economies can be reported for the banks whose asset size extend well into wide range

,(shuffer,1985).

- (COMM):

The result show that net commission income to total asset ratio considering the eight sets of

regression model, have a positive relationship with bank’s net interest margin ,with a significant

impact.

4. Macroeconomic Variables:

The regression results show that macroeconomic developments have insignificant effect on the

Jordanian bank’s net interest margins.

- (GROWTH):

The real growth rate in GDP has appositive impact on bank’s net interest margins , but not

significant ,indicating that movements to deregulation together with technology advances would

lead to improvements in the overall banking businesses ,causing higher spread ,and hence higher

net interest margins.

28

- (INFALTION):

The inflation rate have a positive impact, but not significant. In inflationary environment ,banks

costs generally rise leading to higher borrowing costs for the private sector , suggesting that

banks tend to profit from inflationary environment, by charging higher loan interest rates,and

therefore ,higher net interest margins.

Chapter Four:

CONCLUTIONS AND RECOMMENDATIONS

29

This study has investigated the impact of interest rate liberalization and tax reduction on the

behavior of bank net interest margin in Jordan over the period 1982-2013.

The major finding of our investigation is that the 1989 interest rate liberalization had no impact

on bank interest rate margin, while the 1996 reduction in tax rate paid by the banking sector from

55% to 35% have a significant impact on it, and reduced bank’s net interest margin but not

consider a significant reduction in it, and its remained high and increasing overtime.

Other findings suggest that: bank specific variables explain a substantial part of the within-

country variation in bank net interest margins. High net interest margin tend to be associated with

banks that hold a relatively high amount of capital, we also found a significant role for both the

capital to asset ratio and commission income to asset ratio in the observed levels of interest

margins.

These finding underline the importance of capital adequacy rules as means to prevent banks from

taking excessive risks, and as a tool for maintaining depositor’s confidence. Furthermore, these

findings indicate that more lending results in wider margins, and reflects the bank enhanced

ability to integrate risk considerations in their loan pricing behavior.

In addition to bank-specific characteristics, macroeconomic indicators, such as inflation and real

growth rate in GDP, have no impact on bank’s net interest margins. This finding may suggest that

Jordanian banks work out of macroeconomic conditions.

30

Our results suggest a number of policy recommendations for the banks and policy makers in

Jordan’s banking sector. The most pressing avenue for reform appears to implement further

liberalization to the sector, simultaneously; the authorities should ensure that strong and binding

capital adequacy rules are enforced and that banks are supervised effectively in order to maintain

systemic stability.

Further, the banking sector needs to explore internal as well as industry-driven strategies that

counter some of the bank-specific factors associated with higher spreads. These could range from

diversification of products to investment in cost-saving and efficient form of technology.

31

REFERNCES

Barajas, A., R. Chami, R. Espinoza and H. Hesse (2010), “Recent Credit Stagnation in the

MENA Region: What to Expect? What Can be Done?”, IMF Working Paper No. 219.

Beck, T. and H. Hesse (2009), “Why are Interest Spreads so High in Uganda?”, Journal

of Development Economics 88: 192-204.

Ben Naceur, S. and M. Omran (2010), “The Effects of Bank Regulations, Competition,

and Financial Reforms on Banks’ Performance”, Emerging Markets Review, To be

Published.

Claeys, S. and R. Vennet (2008), “Determinants of Bank Interest Margins in Central and

Eastern Europe: A Comparison with the West”, Economic Systems 32: 197-216.

Demirguc-Kunt, A. and A. Huizinga (1999), “Determinants of Commercial Bank Interest

Margins and Profitability: Some International Evidence”, World Bank Economic

Review 13: 379-408.

Hawtrey, K. and H. Liag (2008), “Bank Interest Rate Margins in OECD Countries”,

North American Journal of Economics and Finance 19: 249-260.

Hermes, N. and V. Nhung (2010), “The Impact of Financial Liberalization on Bank

Efficiency: Evidence from Latin America and Asia”, Applied Economics 42: 3351-3365.

Marinkovic, S. and O. Radovic (2010), “On the Determinants of Interest Margin in

Transition Banking: The Case of Serbia”, Managerial Finance 36: 1028-1042.

Maudos, J. and L. Solis (2009), “The Determinants of Net Interest Income in the Mexican

Banking System: An Integrated Model”, Journal of Banking and Finance 33: 1920-

1931.

32

Mensi, S. (2010), “Measurement of Competitiveness Degree in Tunisian Deposit Banks:

An Application of the Panzar and Rosse Model”, Panoeconomicus 2: 189-207.

Oreiro, J. and L. de Paula (2010), “Macroeconomic Determinants of Bank Spread in Latin

America: A Recent Analysis with Special Focus of Brazil”, International Review of

Applied Economics 24: 573-590.

Perera, S., M. Skully and J. Wickramanayake (2010), “Bank Market Concentration and Interest

Spreads: South Asia Evidence”, International Journal of Emerging Markets 5: 23-37.

Robinson, J. (1952), “The Generalization of the General Theory”, in The Rate of Interest

and Other Essays, MacMillan, London, UK.Rents”, Stanford University Studies in

Industry and Economics No. 77.

Saunders, A. and L. Shumacher (2000), “The Determinants of Bank Interest Rate

Margins: An International Study”, Journal of International Money and Finance 19:

813-832.

Souza-Sobrinho, N. (2010), “Macroeconomics of Bank Interest Spreads: Evidence from

Brazil”, Annals of Finance 6: 1-32.

33

APPENDIX

Table 10. Sample Banks

Bank Name Ticker Origin Type

Arab Bank ARAB National Commercial

Arab Jordan Investment Bank AJIB National Commercial

Bank Al-Etihad UBSI National Commercial

Bank Of Jordan BOJX National Commercial

Cairo Amman Bank CABK National Commercial

Invest Bank INVB National Commercial

Jordan Ahli Bank AHLI National Commercial

Jordan Commercial Bank JCBK National Commercial

Jordan Kuwait Bank JOKB National Commercial

Societe General De Banque

Jordanie

SGBJ National Commercial

The Housing Bank For Trade

And Finance

THBK National Commercial

Banque Audi Not listed Foreign Commercial

34

: اثر ححرير سعر الفائذة وحخفيض الضريبت فائذة في األردنالافي هامش سلوك ص

إعذاد

"علي مصطفى"عزث "محمذ وليذ "جميلت

الوشزف

ذكخور غسان "محمذ خير" أومجالاألسخار

الملخص

فعبال وهوشا ف توت االقتصبد األرد، وال شال إى القطبع الوصزف األرد لعب دورا

الذاعن الزئس للشبغ االقتصبد ف األردى. وهي الوثز لالهتوبم إى القطبع الوصزف شهذ

، واخفبض هعذل 9191سعز الفبئذة عبم زف العقىد األخزة حذثي هبهي، وهوب تحز

.9111العبم % ف55% إل 55العزبت عل أرببح الوصبرف هي

تهذف هذ الذراست إل اختببر اثز تحزز سعز الفبئذة وتخفط العزبت عل سلىك صبف

هصزف 91هبهش سعز الفبئذة ف القطبع الوصزف ببألردى. وهي خالل االعتوبد عل

. ببإلظبفت إل تخوي سبب ارتفبع صبف هبهش سعز 1195لغبت 9191وخالل الفتزة هي

القطبع الوصزف األرد ،وفوب أى السبب عىد الخفبض كفبءة الجهبس الوصزف ، الفبئذة ف

أم عذم تىفز بئت تبفست بي البىك ف هذا القطبع .

وخلصت الذراست إل عذم تأثز صبف هبهش الفبئذة للبىك األردت بتحزز سعز الفبئذة

ل اخفبض غفف لهب ، هع بقبء سعز أدي إ 9111،بوب تخفط هعذل العزبت ف العبم

الفبئذة هزتفع سبب.

Documents

THE BEHAVIOR OF BANK NET INTEREST MARGIN1