Academic journal article European Research Studies

Assessing the Determinants of Interest Rate Spread of Commercial Banks in Oman: An Empirical Investigation

Academic journal article European Research Studies

Assessing the Determinants of Interest Rate Spread of Commercial Banks in Oman: An Empirical Investigation

Article excerpt

1. Introduction

The concept of the interest rate refers to the interest rate levied by the banks on loans or deposits. The interest rate charged on loan is a form of revenue for the bank and at the same time represent the cost borne by the customer for borrowing the money and is termed as credit interest, on the contrary, while interest rates on deposits is cost, the bank is expected to pay to the customers and at the same time represent a form of revenue earned by the customers in exchange for retaining deposits with banks, also termed as debt interest rate. The difference between the debt and credit interest rate from all banking activities are called interest rate spread (IRS). What determines the rate of interest is the credit risk, thus, if the credit risk is high the interest rate on loans is high in order to compensate for the size of this risk. It is also referred to the cost or price of borrowed funds for a period of time, based on the concept of present values the cash value goes down over time due to many factors, including the rate of inflation.

The banking sector provide a bridging mechanism to transfer the money from individuals or companies that have a financial surplus called Surplus Spending units (SSUs) to those who don't have it and seek them often referred to as deficit spending units (DSUs) which start from customers that keep money in the banks as deposits and take interest as compensation as the bank retains their money over a period of time. The Bank then lends money to customers (DSUs) and charge higher rate of interest in order to compensate for the varied risks surrounding the process of lending rate, which means interest rate spread refer to the difference between the debt interest rate and the credit interest rate, resulting in a margin/profit for the bank that contributes to the continuity of banks in the market competition (Kwakye, 2010).

The fast economic development in the entire world led to the inevitable competition in all sectors of the country's economy, including the banking sector, which is considered as the lifeline of the economy. The effect of the increased globalization and financial development particularly the integration of information technology in banking sector exposed the sector to increasing competition and thus resulted in decrease in their interest rate margins.

The interest rate margins are a practiced role in enhancing the profitability and productivity of the banks as they contribute to the budget and the quantum of money supply in the economy and thus the banks played the role of mediator in the macroeconomic environment. The central bank is the main regulator and supervisor of all the banks within an economy which control the total money supply by maneuvering its monetary policies at the macroeconomic level (Folawewo and Tennant, 2008; Boldeanu and Tache, 2016; Allegret et al., 2016; Cipovova and Dlaskova, 2016; Theriou 2015).

The nature of competition among banks in the market depends on the interest rate it is offering to customers on all bank deposits products and on the loans, which determine the kind of margin banks could be able to work on within the market. The lower the margin the better could be the supply of money leading to economic growth and increases in efficiency (Chirwa, 2001; Thalassinos et al., 2013; Fetai 2015). It is therefore important to understand the commercial banks' behavior in the determination of interest rate margin for the purposes of economic growth and to evaluate the banking sector efficiency as any increase in interest rate margin will directly affect the non-banking sector and its efficiency as it will lead to higher operating costs and thus will contributes to reduced lending and investment eventually leading to fall in economic growth.

The old understanding of the margin interest rate is to reduce the cost of funding by entering into financial arbitrage operations related to credit risk, while the modern concept envisage focus on changes in the US market due to changes in the interest rate as a result of fast growth in financial derivatives changes as part of a cash flow hedge instruments against any changes in the interest rate (Folawewo and Tennant, 2008). …

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