Intermediation spread, bank supervision, and financial stability

Abstract

This paper models the effect of bank competition and deposit insurance premiums on the spread between lending and deposit rates. In developing economies, low spreads do not always indicate bank efficiency; they may be the result of high risk taking. This paper shows that imposing upper and lower limits on banks' spreads and adjusting deposit insurance premiums when violation of these limits occurs leads to a more stable but relatively large intermediation costs. In developing economies, such an outcome would be considered more desirable because it insulates existing financial intermediaries and investors against macroeconomic disturbances. © 2010 World Scientific Publishing Co. and Center for Pacific Basin Business, Economics and Finance Research.