·         Research carried out at the Bank of Israel examined data on banks worldwide and found that the net interest margin (net interest income as a percentage of earning assets) is positively related to the level of short term interest rates in the economy.

 

·         It was found that the positive relationship is stronger at low, near-zero, interest rate levels.

 

·         It was also found that when the banking system is concentrated, changes in the interest rate have almost no effect on the net margin. However, in a low interest rate environment, interest rate changes impact the margin in concentrated markets as well.

 

The connection between the level of the interest rate in the economy and bank performance is an important issue in understanding the impact of policy on the banking system and on economic activity, particularly the credit market.

 

New research conducted by Nimrod Segev, Sigal Ribon, and Miki Kahn of the Bank of Israel Research Department, in collaboration with Jakob de Haan of the University of Groningen, uses a broad and detailed database that incudes information on banks in OECD countries for 1995–2019. It examines the factors that impact banks’ net interest margin, and in particular how this spread is impacted by the short term interest rate environment in the economy and by the extent of competition in the country’s banking system. The research is part of a project within the framework of IBRN (International Banking Research Network), an international research group for collaboration among central banks on banking issues.

 

The research finds that the higher the short term interest rate in the economy is, the larger the net interest margin—the gap between interest income on credit and the cost of the banks’ sources. It also finds that in a concentrated banking system, interest rate changes have almost no impact on the net margin. However, in a low interest rate environment, interest rate changes impact on the margin in concentrated markets as well.

 

In recent years, particularly after the global financial crisis in 2008, the short term interest rates worldwide declined markedly, and in many countries they approached very close to zero. Figure 1 presents the range of interest rates in OECD countries over the years, and it indicates the notable downward trend.