Determinants of Interest Spread in Pakistan (Report‪)‬

1. INTRODUCTION Interest spread--the difference between what a bank earns on its assets and what it pays out on its liabilities--has been on an upward course during the last few years, reaching as high as 7.14 percent at end of 2007. An increase in the interest spread implies that either the depositor or the borrower or both stand to loose. In the context of developing economies, the lack of alternate avenues of financial intermediation aggravates the adverse impact of increase in spread. (1) Interest spread also has implications for the effectiveness of the bank lending channel. For example the central bank influences the yield on treasury bills (T. bill hereafter) which affects the deposit and lending rates (2). The change in these rates influences the cost of capital that in turn affects the level of consumption and investment in the economy. If the pass-through of the changes in yield on T. bill rate to the deposit and lending rates is asymmetric then this changes the spread, for better or worse, depending upon the nature of asymmetry. If the increase in spread is due to lower return to depositors then this discourages savings; alternatively if it is due to higher charge on loans, investment decisions are affected. In either case the increase in spread has an adverse bearing upon the effectiveness of bank lending channel of monetary policy and has therefore important implications for the economy (3).