The determinants of net interest margins in asean banks in the period 2008 – 2012

VIETNAM – THE NETHERLANDSPROJECT FOR M.A ON DEVELOPMENT ECONOMICS THE DETERMINANTS OF BANK INTEREST MARGINS IN ASEAN BANKS IN THE PERIOD 2008 – 2012 BY VAN THI THANH NHAN MASTER OF ARTS

VIETNAM – THE NETHERLANDS

PROJECT FOR M.A ON DEVELOPMENT ECONOMICS

THE DETERMINANTS OF BANK INTEREST MARGINS IN ASEAN BANKS IN THE PERIOD

2008 – 2012

BY VAN THI THANH NHAN

MASTER OF ARTS IN ECONOMICS OF DEVELOPMENT

HO CHI MINH CITY – DECEMBER 2014

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

-THE DETERMINANTS OF NET INTEREST MARGIN IN ASEAN BANKS

IN THE PERIOD 2008 - 2012

By

VAN THI THANH NHAN

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

Ho Chi Minh City, December 2014

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE DETERMINANTS OF NET INTEREST MARGIN IN ASEAN BANKS

-IN THE PERIOD 2008 - 2012

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

VAN THI THANH NHAN

Academic supervisor

Dr NGUYEN TRONG HOAI

Ho Chi Minh City, December 2014

I hereby assure that the thesis “The determinants of net interest margin in Aseanbanks in the period 2008 – 20012” was made by me under supervisor of Dr NguyenTrong Hoai

I also certify that data and results of this thesis are honest and have not published

by anyone In addition, the substance of the thesis has not been submitted for any otherdegrees

VAN THI THANH NHAN

In the process of researching is not always convenient and smooth as expected.Sometimes, when I faced with difficulties and challenges I wanted to give up withoutsupport, help and encouragement of whose are always by my side Hence, before Iintroduce the content of this paper I want to send to my loved ones deepest gratitude

To my parents and my big family who are always beside and have instructed me

on my ways whenever I am failure or successful

To my beloved husband who always encourage, motivate me not only in theprocess of completing this study but also in the life Thank you, love you so much

To my beloved daughter, thanks my angel who has given me the impetus fromlove and responsibility so that I can awake at night and work hard Thanks for helping meforget all the fatigue and back down when I look at you

Thank to Dr Nguyen Trong Hoai who has always supported me in this process.Thanks for your reminder and encouragement so that I could complete this paper

Especially, thank for giving me can feel the love and confidential teacher

To the Doctors, tutors in VNP program have imparted knowledge with all ofpassion, enthusiasm Thanks to the other employees, students in the program support mewhen I study in VNP program

To the friends, colleagues has supported and facilitated during the completion ofthis research

VAN THI THANH NHAN

TABLE OF CONTENTS

Certification 3

Acknowledgement 4

List of figures 8

List of tables 9

Abbreviations 10

Abstract 11

CHAPTER 1: INTRODUCTION 1.1 Problem statements 12

1.2 Research objectives 17

1.3 Research questions 18

1.4 Research scope 18

1.5 Research structure 18

CHAPTER 2: LITERATURE REVIEW AND CONCEPTUAL FRAMEWORK 2.1 Literature review for interest margins 19

2.1.1 Definition of net interest margin 19

2.1.2 Determinants of NIM 21

2.1.2.1 Related literature 21

2.1.2.2The macroeconomic factors 23

2.1.2.3The bank specific factors 24

2.1.2.4 The banking market factor 27

2.2 The suggested research approach 32

2.3 The concept framework 34

CHAPTER 3: RESEARCH METHODOLOGY AND DATA COLLECTION 3.1 Identification of variables 36

3.1.1 The dependent variable 36

3.1.2 The independent variables and hypothesis testing 36

3.1.2.1 The macroeconomic factors 36

3.1.2.2 The banking market factor 38

3.1.2.3 The banking specific factors 38

3.2 Data collection and expected results 43

3.3 The research methodology 45

3.3.1 The model 45

3.3.2 The estimation method 45

3.3.2.1 Fixed Effect Model 45

3.3.2.2 Random Effect model 47

3.3.2.3 Selecting the appropriate model 48

3.4 The outline of estimation method 48

CHAPTER 4: DATA ANALYSIS AND DISCUSSION 4 1 Descriptive statistical analysis 50

4.1.1 The data description 50

4.1.2 The summary statistic 51

4.1.3 Testing for correlation relationship 54

4.1.4 Checking for multicollinearity 54

4.1.5 The relationship between independent variables and Net interest margins 55

4 2 Econometric estimation and testing models: 61

4.2.1 Whether FEM or REM is more consistent 62

4.2.2 Fixed Effects Model 63

4.3 Empirical findings 65

4.3.1 Hypothesises rejected 65

4.3.2 Hypothesises accepted 65

CHAPTER 5: CONCLUSION AND RECOMMENDATIONS 5.1 Conclusion 68

5.2 Policy Recommendation 69

5.3 Limitation and further research 71

REFERENCES 72

APPENDIX A 77

APPENDIX B 79

LIST OF FIGURES

FIGURE 1: GDP growth rate in main regions and countries, 2005 – 2009 14

FIGURE 2: The growth rate of worldwide industrial exports, 2005 – 2009. 15

FIGURE 3: GDP growth rate from 2008 to 2009 in Asean countries 16

FIGURE 4: Inflation rate from 2008 to 2012 in Asean countries 16

FIGURE 5: Trend of Net Interest Margins in Asean banks from 2008 – 2012 17

FIGURE 6: The relationship between GDP and NIM 56

FIGURE 7: The relationship between INF and NIM 56

FIGURE 8: The relationship between HHI and NIM 57

FIGURE 9: The relationship between SIZE and NIM 57

FIGURE 10: The relationship between LIQ and NIM 58

FIGURE 11: The relationship between CRD and NIM 58

FIGURE 12: The relationship between CAP and NIM 59

FIGURE 13: The relationship between OPE and NIM 59

FIGURE 14: The relationship between IIP and NIM 60

FIGURE 15: The relationship between MGE and NIM 60

LIST OF TABLES

Table 1: Feature and source of variables 43

Table 2: Data description 50

Table 3: Deterministic statistic of main variables 51

Table 4: Correlation coefficient of variables 54

Table 5: Testing for multicollinearity 55

Table 6: Comparison of regression result of FEM and REM 61

Table 7: Testing for selecting appropriate model 62

Table 8: Results of Fixed Effect Estimator 63

Table A: The summary of main literatures review 28

ASEAN : Association of Southeast Asian Nations 11

GDP : Gross domestic product 17

CEE : Central and Eastern Europe 22

CPI : Consumer Price Index 37

FEM : Fixed Effect Model 11

REM : Random Effect Model 11

WB : Work Bank 11

IMF : International Monetary Fund 14

LSDV : Least Square Dummy Variable 46

FGLS : Feasible Generalized Least – Squares 46

This study investigates the determinants of bank interest margins in Association ofSoutheast Asian Nations (Asean) banks over the period 2008 – 2012 by using of a paneldata set In this research, the Hausman test will be used to make my choice is (FFM)Fixed Effect model or Random Effect model (REM) to analyze impact factors on the netinterest margins (NIM) In addition, the data serving for research come from the WorldBank (WB) Indicators database and Bankscope database According to the expectedresults, there will be three main group impacts on bank margins: the bank specificcharacteristics, the macroeconomic conditions, the banking market characteristics Theresults do not indicate that macroeconomic factors and structure of market have anyimpact on net interest margins In the banking characteristics, the paper finds that there isonly capital adequacy, implicit interest payment and managerial efficiency effecting onbank margins Based on these findings, the policy makers can advance petitions andpolicies for managing bank margins effectively following developing strategy of banks

by controlling significant effects on bank margins; namely capital adequacy, implicitinterest payment and quality of management

Keyword: Net interest margins, determinants, Asean, bank.

CHAPTER 1: INTRODUCTION

1.1 PROBLEM STATEMENTS:

Bank systems play a cruel role in the modern economy, banks are considered asintermediate institutions in social Efficiency of financial intermediaries influences ondeveloping economy with specifics example in India (Sathye, 2003) As a good example,development and efficient of banking system impacted on Hungarian economy intransitional period (Hasan & Marton, 2003) On the other hand, the banking sector playsimportant role in monetary policy in Europe through deposit and lending channel,

(Kashyap & Stein,1997), this paper proclaim that the degree of bank dependence oncustomers and ability of bank are main factor on setting up monetary for the Europeanmonetary union The more efficient banking systems, the better economy stand shock.Similarly, efficiency of banking system is an important part in stabilizing economy

(Athanasoglou, Brissimis and Delis, 2005) and (Sbracia & Zaghini, 2003) At the sametime, the banking sector is seen as a bridge between the different sectors of the economy,the economic bridge between regions and nation together Because of the important role

of the banking system, the performance of the banking system has been considered one ofthe important issues in the country’s economy in particular and the world economy ingeneral Bank activities in many different fields such as deposits, credit, banking services,money transfers,… and the other finance fields securities, real estate, etc However, theactivities which bring main profit for bank are deposit and lending, they are seem aspecific areas of banking system Hence, Banks play a crucial role as the financialintermediary

The traditional business operation of bank is that loans and deposits, bank collectsfunds from customer’s deposit and meet demand loans base on this funds, so when thecost of fund is high, it will effect on bank profitability Net interest margin is supposed atypical indicator for relationship between deposits and loans of bank NIM can be

measured by two ways In the first method, NIM is calculated by difference between loaninterest rates and deposit rates According the second way, NIM is measured by thedifference between interest income and interest expenses of bank divide by total assetsfor the period considered, data of interest income and interest expenses, total assetsusually get from the financial statement The interest income stands for the result of bankafter taxes for the period surveyed, the interest expenses is represented the cost ofdepositing funds in the current period In general, the second method was used in mostprevious studies on the NIM such as Ho and Saunders (1981), Angbazo (1997), Saundersand Schumacher (2000), etc and most NIM published by banks is calculated incomestatement based on the second method.

As for the impact of NIM on banking operation, Demirgüç-Kunt and Huizinga(1999) reply that the largely on deposits for fund will have less profitability becausecovering the cost of funds increase, they also found that stable and efficient bankconcentrate on banks margins and profitability, the bank interest margins should not betoo large Typical representative of banking cost and efficiency is net interest margins Asmost of previous studies, the net interest margin is calculated as the gap between interestincome and interest expense by percent of total earning assets will influence on bank’sefficiency As a result, NIM can be used an indicator of the banking sector At the sametime, an efficient intermediation cost as indicated by a low rates of net as well as reflectsthe effectiveness of monetary policy and financial stability (Hadad et al, 2003) Bycontrast, high costs would reduce the incentive for economic actors Raharjo et al (2014)proved that the banking sector is heathy and able to create more profit, it will can towithstand shocks and contribute to the stability of financial system In a country, thefinancial sector is dominated by banking sector, any failure in this sector has an immenseimplication on the economic growth of the country Hence, as a fact, any bankruptcy orpoor performance in banking sector has a contagion effect that can lead to bank runs,crises and bring overall financial crisis and economic tribulations (Ongore and Kusa,2013) Therefore, this research wants to analyze the determinants of net margin in the

financial period, so that can found significant factor and base on that to improve heath ofbank through net interest margins.

In the period 2008 -2012, the global economy was under pressure from the financialcrisis in the United State at all sectors such as industry, services, finance,…Especially, thebanking sector was affected significantly by this crisis For example, bankrupt of severallarge American banks as Lehman Brothers Bank which was the fourth largest in UnitedState in 2008, the Integra Bank Corp in 2011 and a lots of smaller bank over the period

2008 – 2012 The instability of the largest banking system affected whole of bankingsystem in the world, in which the Asean banks were not exceptional Period 2008 -2009was considered as the worst economic crisis of the world economy The major economiessuch as America, Japan and Europe fell into recession, GDP declined dramatically,unemployment rate increased highly, a lot of companies bankrupt,… Some countries fellinto negative GDP growth as the EU (-0.5%), Germany (-0.8%), the United States (-0.7%), Japan ( -0.2%)some countries like Russia and only 3 , 5% and China from 10% to8% in 2008 (Figure 1) In addition, Figure 2 also show that the growth rate of worldwideindustrial exports decreased remarkably from 2007 t0 2009

Figure 1: GDP growth rate in main regions and countries, 2005 - 2009

14 12 10

-14-Source: International Monetary Fund (IMF) and Author’s calculation

Figure 2: The growth rate of worldwide industrial exports, 2005 – 2009.

Source: Source: IMF and Author’s calculation

Grigor and Salikhov (2009) discussed the main causes of this crisis, of which higheconomic growth rates worldwide since the beginning of the 2000s against thebackground of serious savings imbalances; Negative real interest rates in developedcountries; De facto weakening of financial sector regulation with the sudden expandeduse of new financial instruments were main factors of developing the global crises

Fidrmuc and Korhonen (2010) have demonstrated the powerful impact of the global crisis

on business cycles in Asian developing countries It found that there was a negativesignificant impact between the global crises in 2008 to economic development of OECDcountries, namely decline of GDP growth rate and low level of business cycle wereresults of this crisis in OECD countries Ivashina and Scharfstein (2010), Aisen andFranken (2010) showed the effect of the crisis on a bank credit which was main activities

of banks Period 2010 - 2012, the world economy began to recover from the shock of thecrisis still lingers to the crisis

The crisis developed and spread to other Asian countries, including the countries ofthe ASEAN region In ASEAN countries, Figure 3 showed that GDP growth rate

fluctuations during the period 2008 - 2012, including the period 2008 - 2009 GDP slump.However, GDP growth rate began to recover over the period 2010 – 2012 Similarly, theinflation rate also declined dramatically during 2008 – 2009 in most Asean countries, and

in 2010 -2012 the inflation rate became more stable (Figure 4)

Figure 3: GDP growth rate from 2008 to 2009 in Asean countries.

Source: Work Bank (WB) and Author’s calculation

Figure 4: Inflation rate from 2008 to 2012 in Asean countries

Source: WB and Author’s calculation

On the other hand, Figure 5 showed the trend of NIM in Asean banks from 2008 to

2012 NIM is seemed as the proxy of banking efficiency Hence, fluctuate of NIM willeffect on efficiency, profit of banks In this crisis period, the net interest margins tend todecline in Asean countries The Figure 3 showed the trend of mean NIM in Asean banks

over the period 2008 -2010 The graph shows a downward trend in the epicenter of the

crisis period 2008 – 2010 and during the recovery phase of economy from 2010 – 2010,

NIM has fluctuated Therefore, this study wants to find out the factors that have affected

the volatility of NIM after the world economic crisis

Figure 5: Trend of Net Interest Margins in Asean banks from 2008 – 2012

The goal of the study:

The main goal of this study is to model and measure the significant determinants

of the net interest margins in Asean banks including ten (10) factors: Gross Domestic

Product (GDP) growth rate, Inflation rate, banking market structure (represented by

HHI), Bank size, Liquidity risk, Credit risk, Capital adequacy, Operating cost, Implicit

interest payments, Managerial efficiency At the same time, to draw empirical conclusion

and suggest some policy recommendations for decision makers

Specific objectives:

To meet this goal, specific objectives are set out:

1. Determine the factors, magnitude, sign and significant level of determinants of NIM

2. Inferring conclusions to suggest recommendations

1.3 RESEARCH QUESTIONS

To solve objective of this paper, the relevant questions are answered:

1. What factors influence on the bank interest margins in Asean banks?

2. How those factors impact on the bank interest margins?

3. To recommend general policies for managing bank interest margins of Aseanbanks Which policy recommendation to manage NIM?

1.4 RESEARCH SCOPE

The study will cover determinants impact on bank interest margins in 9 Aseancountries (Brunei, Cambodia, Malaysia, Philippines, Laos, Vietnam, Singapore, Thailand,and Indonesia) from 2008 to 2012 In fact, Asean region have 10 members includingBrunei, Cambodia, Malaysia, Philippines, Laos, Vietnam, Singapore, Thailand, Indonesiaand Myanmar However, there was a limitation of collecting Myanmar data so it will beeliminated Myanmar from this study

1.5 RESEARCH STRUCTURE

The rest of the research is organized as follows Chapter 1 explain reasons of choosethis theme and main goals of research Chapter 2 outlines the literature reviews andconceptual framework on the determinants of net interest margins Chapter 3 describesthe research methodology and data Chapter 4 presents the main results of analysis.Chapter 5 concludes and gives some policy recommendation

CHAPTER 2: LITERATURE REVIEW AND CONCEPTUAL

FRAMEWORK

2.1 LITERATURE REVIEW FOR INTEREST MARGINS

2.1.1 DEFINITION OF NET INTEREST MARGIN:

NIM is preceded from the relationship between deposits and lending at the bank.The bank mobilize funds of depositors by deposit interest rate giving, after that the bankinvest these funds by giving loans for borrowers with higher interest rate Net interestmargins analysis is one way of measuring the cost of financial intermediation, thedifference between the cost of interest paid by the borrower to the bank and depositorsreceived interest income (Brock and Suarez, 2000) So that the bank set up the rates forloans and deposit as follow:

RL = r + b

RD = r – a

In which:

RL : the rate on loans

RD : the rate on deposits

R : risk – free interest rate

a: fees charged on loans

b: fees charged on deposits

And the pure margin is:

R L - R D = a + b

Determinant of net margins can be explained using two approaches, namely thetraditional approach and modern approach The traditional approach views of variablesthat affect the NIM are done by analyzing the balance sheets of bank, whereas themodern approach by taking into account demand and supply rate on the microstructure of

the bank Almost previous studies based on modern approach Therefore, NIM is the ratio

of net interest income to total earning assets of banks and this indicator usually published

by bank report annually Net interest income is the difference between interest incomeand interest cost earned on interest expense paid A study conducted by Ho and Saunders(1981) is a pioneer in analyzing the NIM to make banking model as intermediarybetween recipient and the channeling of funds Ho and Saunders (1981)’s model arguethat the bank faces reinvestment risk at the end of the decision period should the short –term rate fall, hence the fees a and b must compensate the bank for bearing this interestrate Hence the fees a and b are optimal and the optimal interest margin is:

(*)

In which:

s : the difference between lending and deposit rates

/ : bank’s risk neutral spread

Q : size of bank transactions

2 ; the instantaneous variance of the interest rate on deposits and loans

R : the bank management’s coefficient of absolute risk aversion

Ho and Saunder (1986) defined NIM as the spread between the interest revenue onbank assets and interest expenses on bank liabilities as a proportion of average bankassets Similarly, Dietrich, Wanzenried and Cole (2010) showed that the net interestmargin is the difference between a bank’s interest income and interest expense expressed

as a percentage of interest earning assets In the study of Raharjo, Hakim, Manurung andMaulana (2014), NIM is measured by the ratio of the net interest income to average totalearning assets of banks Net interest income is the difference between interest income andinterest costs earned on interest expense paid while the earning assets that are accountedfor productive assets that generate interest Besides, net interest margin was specified by

the difference between the cost of interest paid for the borrower and depositors receivedinterest income in Brock and Suarez (2000)’research In general, above definitions havedifference phrase but the same meaning about NIM In this study, NIM will be measured

by the ratio of net interest income to total earning assets, while net interest income iscalculated by interest income minus interest expenses The database of NIM is provided

by Bankscope so there is an advantage when using Banksope data because ofhomogeneousness among the database of NIM across countries

2.1.2 DETERMINANTS OF NIM

2.1.2.1 RELATED LITERATURE:

Ho and Saunders (1981) is one of first persons who examine about determinants ofnet interest margins The result showed that main determinants of NIM includes interestrate volatility, size of transactions, risk aversion and market competition by using the twostep regression procedure In the first step, the NIM was estimated by regression on bankspecific characteristics and in the second steps, NIM was estimated by macroeconomicsand market structures characteristics In the dealership model of Ho and Saunders (1981),the bank plays a role as a risk averse which facing with cost of fund in loans and depositmarkets There are many studies based on Ho and Saunders (1981)’s model to analyze netinterest margins according to different aspects

Wong (1997) also extended the model of Ho and Saunders (1981) It found thatcredit and interest rate risk are affected on NIM based on the simple firm – theoreticalmodel This firm – theoretical model was based on behavior of risk-averse bank withNIM under credit risk and interest rate risk The results of this paper gave informationabout positive relationship between NIM and market power, operating cost ad credit risk;simultaneously, there was a positive impact of interest rate risk on bank interest margins.Relying on the dealership model of Ho and Saunders (1981) , Saunders and Schumacher

(2000) also employed the two step procedure to find impacts on NIM in some countriesare that Germany, Italy, Switzerland, UK, Spain, France, US over the period 1988 – 1995under implicit interest rate, the opportunity cost and credit risk On the other hand, Claeysand Vander Vennet (2008) used random effect estimator to compare different determinant

of NIM between Cemtral and Eastern Europe and the West The study examined thatinterest rate volatility and regulatory restriction such as minimum capital, liquid reservesrequirement, implicit interest rate effected on NIM significantly Angbazo (1997) alsobased on the dealership model of Ho and Sauders (1981), Mcshane and Sharpe (1985)and Allen (1988) to explore the interest rate risk, default risk, liquidity risk and off-balance sheet is consistent with fluctuation of NIM for 1989-1993 with 1400 observations

on 286 commercial banks from the Call Report data By contrast, Lin et al.(2012) appliedthe switching regression model for their research about banks margins on diversification

at banks in some Asian countries as China, India, Indonesia, Japan, Philippines,Singapore, South Korea, Taiwan and Thailand from 1997 to 2005 The findings showedthat NIM can be sensitive because of bank risk factors as liquidity risk, interest rate risk,credit risk, implicit interest payment, etc and other factors calculated from balance sheetand income statements As most of other study, Dumičić and Ridzak (2012) also dealwith determinants of NIM in Central and Eastern Europe ( CEE) based on Ho andSaunders (1981) model of period 2000 – 2010 but by fixed effect estimator In the EU,Maudos and Guevara (2004) also extended Ho and Saunder(1981) dealership model toexplain factors on the NIM, this paper give result that NIM is consistent with marketpower, concentration positively but have a negative relationship with interest rate risk,credit risk and operating cost In addition, the study by Kasman, Tunc, Vardar and Okan(2010) included the bank specifics, country – specific market characteristic andmacroeconomic conditions to demonstrate NIM is related to those characteristics andconsolidation also impact on NIM in new and old EU Hence, the model of Ho andSaunder (1981) is considered as basic model for net interest margins At once, this modelalso deal with the determinants of NIM relied on Claeys and Vander Vennet(2008) andLin et al.(2012) as main literatures for analyzing Most previous studies have used panel

data to analyze; some studies used data from banks of a country with over the years such

as Ho and Saunders (1981) employed panel data from American banks over the period

1976 to 1979 Similarly, Entrop, Memmel, Ruprecht and Wilkens, (2012) determinedeterminants of NIM in Albanian banking system from 2001 to 2007; Fungacova andPoghosyan (2009) consider factors effected on NIM through data from Russian banks inperiod 1999 - 2007.; Williams (2007) also used panel data from 1989 to 2001 to analyzedeterminants of NIM in Australia As a whole, in this case panel data is time series data.However, a lot of papers use data from many different countries at the same few periods

In detail, Saunders and Schumacher (2000) employed data from seven countries to provethe relationship between NIM and implicit interest rate, opportunity cost, credit risk in

1988 – 1995; the same thing, Claeys and Vander Vennet (2008) used panel data of 36countries of Western and Eastern European from 1994 to 2001 and so on And in thisstudy, the author use panel data in many countries in the period surveyed of 5 years from

2008 to 2012 Many of the previous studies (Claeys & Vander Vennet, 2008; Dumičić &Ridzak, 2012; Kasman et al, 2010) separated factors into different group includingmacroeconomics factors, banking market specific and bank specifics variables In thispaper, independent variables are divided by three group factors includingmacroeconomics factors, banking market specific and bank specifics variables

2.1.2.2 THE MACROECONOMIC FACTORS:

To consider macroeconomics variables, this group of factors consider factors

which shows how the health of a national economy to influence on NIM There are manyindicators, parameters representing the economic situation of a country such as GDP,inflation, exchange rates, interest rate, trade of goods, and so on However, in this studyGDP Growth and Inflation rate was chosen as proxies for the macro factors fordemonstrating influence of the economy to the NIM Lots of empirical studies have alsodemonstrated the effects of GDP and Inflation on the NIM; the majority of papers havedemonstrated that the GDP impact on NIM (Schwaiger & Liebeg, 2008; Ben Naceur &Goaied, 2008; Ben Naceur & Goaied, 2008; etc.).Meanwhile, regard to inflation,

Dumičić and Ridzak have proved an impact on NIM inflation negatively in CEE.Kasman, Tunc, Vardar and Okan (2010)’s study showed that there was a contra – variantimpact on NIM Aliaga-Dıaz and Olivero (2005) said that high inflation is associated withhigher cost and also higher income The positive relationship posits that bank incomeincreases more with inflation than bank cost This paper uses GDP growth rate andinflation to analyze their impacts on interest rate margins Demirgüç-Kunt and Huizinga(1999) suggested that inflation increases the bank cost, hence, it makes bank interestmargins and profitability rise Although inflation have the significant positive coefficientwith bank interest margins and profitability but it is low As regard to GDP growth rate,

no impact on NIM and profitability (Demirgüç-Kunt & Huizinga, 1999) In addition, thefindings of Claeys and Vander Vennet (2008) shows that the high GDP growth rate willhave high margins in (CEE) Central and Eastern European as well as inflation also havesignificant positive impact on margins

2.1.2.3 THE BANK SPECIFIC FACTORS:

With regards to bank-specific variables, this group muster element of bankingperformance effecting on NIM Normally, the most of variables come from incomestatement and balance sheet or other reports with parameters However, this paper justemploys some variables based on empirical literatures

Ho and Saunders (1981) studied the factors affecting on NIM including bankspecifics factors and outside factors such as the macroeconomic characteristics, marketstructure by the two step regression In the first step, the authors regression relationshipbetween NIM and the elements inside the bank, in a second step the authors analyze therelationship between NIM and other factors such as macro-economic factors, legal and so

on, the results also showed that the banking specifics elements including managerial, riskaversion, the size of the transaction, and the degree of market competition and thevariance of interest rate impact on fluctuation of NIM at US banks over the period 1976-1979

In the CEE region, Claeys and Vander (2008) have used the balance sheet andincome statement to analyze the immanent factors within the bank as bank capitaladequacy, the ratio of equity to assets task, in 36 Countries with 2279 CEE bankstotally The author also shows that the more banks operate efficiently, the more the NIM

is lower in countries joined the EU, but not true in countries that do not join EU Das(2013) studied the factors affecting NIM during the global financial crisis of banks inIndia, the author has classified the factors into three groups, in which there was a bankspecifics group including bank size, liquid asset, asset share, non - performing assets, costinefficiency, capital cushion

Angbazo (1997) detect credit risk and liquidity risk increases NIM at US banks inthe research “ commercial ban net interest margins, default risk, interest rate risk and offbalance sheet banking” in 1997 From pervious empirical papers together with collectingdata, this study have seven independent variables belong to bank – specific characteristicsembracing bank size, credit risk, capital adequacy, liquidity risk, operating cost, implicitinterest payments , managerial efficiency Some variables found from empirical researchbut it is difficult to find data for Asean banks so they cannot employ on this paper

- Operating cost

With operating cost, research of Hawtrey and Liang (2008) about the bank interestmargins considered that the impact of operating cost is positive statistically significantwhich implies that banks may impose an extra interest margin to cover the high operatingcost Operating cost is by far the most important driver of NIM in the new EU memberand candidate countries’ banking system It has a significant positive relationship with netinterest margin, which implies that banks may require an extra interest margin to coverthe high operating cost (Kasman, Tunc, Vardar & Okan, 2010) Zhou & Wong, 2008) alsofound that average operating cost remarkably effect on NIM in commercial bank inmainland China

- Implicit interest payments:

About implicit interest payments, Angbazo, L (1997) the increasing of implicitinterest payments will make cost increase, so NIM will go up This finding also supported

a lot research about NIM such as Hawtrey, K., & Liang, H (2008); Zhou, K., & Wong,

M C (2008); Maudos, J and de Guevara J.F (2004); Lin, J R., Chung, H., Hsieh, M H.,

& Wu, S (2012) Implicit interest payment is considered a most factors of NIM,because it directly effects on lending rates and deposit rates of banks Banks givemany services for customer but it is not quietly free, cost of these services will beadded on rates for customers Hence, there is a positive relationship between IIPand NIM

- Managerial efficiency

According to managerial efficiency measure quality of management, typically,banks which have effectively managed will bring more profit than other banks and soNIM is higher ( Angbazo (1997) Hawtrey, K., & Liang, H (2008)) However, in EU,Kasman, A., Tunc, G., Vardar, G., & Okan, B (2010) found that the bank offer higherdeposit rates and lower lending rates when cost for ME increases

2.1.2.4 THE BANKING MARKET FACTOR:

The third factor is banking market variable, measuring the degree of concentration

in the market structure In a lot of papers, the Herfindahl index is used to consider as aproxy for market concentration For instance, Maudos and Guevara (2004)’s study getHerfindahl index as proxy, the result of this research show that NIM is effected positivelyand highly significant by this index Furthermore, the concentration is one of maindeterminant impact on interest margin in CEE (Claeys & Vander Vennet, 2008), as otherresearches, the Herfindahl index represented concentration impacts on margins positivelyand highly significant Similarly, Demirgüç-Kunt and Huizinga (1999) found that thebank concentration ratio influence on both bank margins and profitability and trend ofhigh margins in large banks

Table A: the summary of main literatures review

Ho and Saunders 1

(1981).

Angbazo 2

(1997)

Claeys and Vander 3

Vennet (2008)

5 Saunders

and Schumache

and de Guevara (2004)

Lin, 8

Chung, Hsieh and

Wu (2012).

11

Demirgüç-Kunt and Huizinga (1999)

Dietrich, Wanzenrie

2.2 THE SUGGESTED RESEARCH APPROACH:

The study of NIM was researched firstly by Ho and Saunders (1981 In the dealership model of Ho and Saunders (1981), the bank was suggested as a risk-averse

-31-dealer as the financial intermediaries The classical operation of bank is intermediariesbetween suppliers and demanders of funds through deposit rates and credit rates Banksmobilize fund in the money market from supplier’s funds applied deposit rates and meetdemand loans for demanders of funds with loan rates relying on these fund mobilized inthe market A risk-averse dealer must face asymmetric arrival of demands for loans andsupplies and of deposits (Zhou, K., & Wong, M C (2008).), it means that when a depositcome bank need a loan demand and vice versa On the other hand, period of deposits arenot same together and with period of loans, so interest rates set up different and bankmust calculate cost of these funds most appreciate Simultaneously, lending and depositoperation should be held in a harmonized manner to banks avoid the risk of interest rates

in the money market Normally, borrowers usually have long-term capital needs whileperiod of deposits are usually shorter so the balance of funds in this operating bank isvery important activity, banks often rely on interest rates to attract capital Besides, bankshave to reinvest funds without loans demand to cover the cost of deposits Hence, banksconfront with several risks as interest rate risk, default risk, credit risk, Angbazo ( 1997)had extend Ho and Saunders (1981) with adding risk factors on NIM

The dealership model of Ho and Saunders (1981) becomes the basic model for lastresearchers about net interest margins Angbazo(1997), Saunders and Schumacher(2000), Claeys and Vander Vennet(2008), Maudos and de Guevara (2004) developed thisNIM model in their studies Furthermore, Angbazo (1997) and Maudos and de Guevara(2004) extended model of Ho and Saunders (1981) as follow:

? "(? ? )

? (? ? ) 4

Where:

? ? ? + ? ? ? : The structure of the market for loans and deposits.

? ?

? ?

?? (?? ) + ? (?? )? : The average operating cost.

(? + 2? 0 ) : The total volume of credits

(? + ? ) : The average size of the credit and deposit operations undertaken by the

bank

This model analyzes determinants of NIM under risk factors of the spread betweenlending and deposit rates in the money market Angbazo (1997) explored the more riskyloans and higher interest rate, the higher bank interest margins in US commercial banksfor 1989 – 1993 NIM is affected by market power, interest rate risk, credit risk andoperating cost in EU banks during the period 1993 – 2000

The NIM model of Ho and Saunders (1981) is employed in a lot of empiricalresearch with different aspects Kasman, Tunc, Vardar and Okan, (2010) find therelationship of consolidation and commercial bank net interest margins with evidencefrom the old and new European Union members and candidate countries Aliaga-Dıazand Olivero (2005) applied the dealership model of Ho and Saunders to find the cyclicalbehavior of Net interest margins in US banks On the other hand, the relationshipbetween net interest margin and market interest rates was found in English, W B.(2002)’s study In addition, Fungáčová and Poghosyan (2011) proved that NIM concernwith ownership factors in Russia Dietrich, Wanzenried and Cole (2010) concluded thatnet interest margins are different across countries because of bank specific factors andmacroeconomics variables

2.3 THE CONCEPT FRAMEWORK:

-33-Net Interest Margin

Macroeconomic Banking market

characteristics Bank-specific characteristics

SUMMARY CHAPTER 2

The chapter 2 gives an overview on theoretical literature about net interestmargins and determinant of net interest margins including GDP growth rate,inflation rate, market structure, scale of bank, liquidity risk, and credit risk, capitaladequacy, operating cost, implicit interest payments and managerial efficiency Inaddition, this chapter specifies the computing method of each variable andpresents the appropriate empirical model for this research based on the theoreticalmodels of Ho and Saunders (1981) and Angbazo (1997) Furthermore, theconceptual framework is established on theoretical literature reviews showed

CHAPTER 3: RESEARCH METHODOLOGY AND

DATA COLLECTION

3.1 IDENTIFICATION OF VARIABLES:

3.1.1 THE DEPENDENT VARIABLE:

To approach net interest margin, there are two way In the first method, NIM ismeasured as the difference between the contractual interest rates for deposits and loans.Secondly, NIM is calculated the difference between the interest income and interestexpenses in the period considered In case the first method contains more disadvantagesthen the second, because there are many different sources for deposits and loans at thebanks, so they can not correspond with together However, the second also have weakpoint, Demirgüç-Kunt and Huizinga (1999) reckoned that the interest income and interestexpenses have tend to materialize in different periods With the second one, the data will

be based on the financial statements of the banks

In this study, net interest margin has defined as the cost of intermediationmeasured by the difference the gross paid by the borrower and the interest incomereceived by depositors (Bernake, 1983 and Brock & Suarez, 2000) As a lot of empiricalpapers, NIM is calculated as the difference between interest income and interest expenses

as a proportion of total earning assets (Claeys & Vander Vennet, 2008; Dietrich, A.,Wanzenried & Cole, 2010; Entrop, Memmel, Ruprecht, & Wilkens, 2012; ect ) Data forNIM will be gotten from the Bankscope

3.1.2 THE INDEPENDENT VARIABLES AND HYPOTHESIS TESTING:

3.1.2.1 THE MACROECONOMIC FACTORS:

GDP growth rate (GDP) variable belongs to macroeconomic factor; GDP is

measured by the GDP per capital growth rate GDP growth rate represents the

economic growth of each country Changing of economic growth will effected onprices, cost and business cycle because of financial monetary policies changed tocontrol the market Therefore, economic growth may affect in NIM Most previousstudies have same results is that there the positive relationship between GDP andNIM In Western European bank markets, Claeys and Vander Vennet (2008)showed that there is the positive association between business cycle and NIM Theresults reflect the higher economic growth is related with higher net interestmargin The higher GDP growth give more opportunities and more demand forcredit and make increase the bank margins (Dumičić & Ridzak, 2012) In contrast,Ben Naceur and Goaied (2008) has proved that there is not relationship betweeneconomic growth and NIM in Tunisia similar to Ben – Kediri et al (2005)‘sfinding Data for GDP growth rate from 2008 to 2012 of Asean countries in thisresearch come from World Bank.

Hypothesis 1: Economic growth (GDP) is expected a positive significant impact

on NIM The greater economic growth will have a higher net interest margins.

Inflation rate (INF) is inflation rate calculated by the changing of Consumer

Price Index (CPI) Inflation rate is considered as a factor effecting prices of

markets Purchasing power in the market will decrease when inflation rise,

normally, high inflation concern high interest rate of deposits and loans Hence, inflation is suggested as macroeconomic element effect on changing of NIM In Kasman et al (2010), the increase of inflation rate make cost and income be higher, there was a positive relationship between inflation rate and NIM In

Indonesia, cover the period 2008 – 2012 too, Raharjo, Hakim, Manurung andMaulana (2014) found that inflation has a positive significant effect on NIM

Hence, inflation rate can be positive and negative sign in this model As GDP growth rate, inflation data will get from World Bank