The effect of market structure on banks’ interest rate spreads : an empirical analysis of the Norwegian bank market

Abstract

In this study we investigate how market structure affect the interest rate spread of banks that provide lending for commercial entities in Norway. We delineate the Norwegian bank market into local commuter belts, and define the commuter belts as either high- or low concentration regions depending on their level of market concentration, measured by the Herfindahl- Hirschman Index (HHI). Regions with HHI-levels above 0.20 are defined as high concentration regions whereas regions with HHI-levels equal to and below 0.20 are defined as low concentration regions. We analyze how market concentration along with other potential determinants affect the interest rate spread of banks in both high- and low concentration regions over the years 1998 – 2008 using panel data regression methods. In high concentration regions, we find that a 0.10 increase in market concentration increases the interest rate spread by 3.64 basis points. However, there is no evidence that market concentration affects interest rate spreads in low concentration regions. Our analysis further reveals that market share, based on loan levels, has a negative impact on the interest rate spread in both high- and low concentration regions. The study is based on unique banking data, which we use with permission from the Norwegian Ministry of Finance. The data provides an extensive overview of the Norwegian banking sector from 1998 – 2008.