INTEREST RATE SPREADS IN AN EMERGING ECONOMY: THE CASE OF PAKISTAN'S COMMERCIAL BANKING SECTOR

This paper explores the determinants of interest rate spreads in Pakistan's commercial banking sector in post transition period (2004 2009) using an exhaustive set of macro and firm level variables to analyze their impact on intermediary efficiency. We introduce two innovative variables of default likelihood indicator (Black Merton and Scholes option pricing framework) and proportion of public sector deposits in total deposits to explain the variation in spreads. The results suggest that intermediary efficiency is affected by bank size, operational efficiency, asset quality, liquidity, risk absorption capacity and GDP growth rate. There is evidence for deposit market share as well as deposit market concentration establishing the presence of an interest sensitive deposit market. We could not find support for impact of interest rate volatility and financial development indicator on banking spreads.