Question

Financial frictions are often described in terms of an “interest-rate spread” between a standard government debt (like the 3-month or 10-year treasury bonds) and private debt (like commercial paper, BAA bonds etc.). When would this “interest-rate spread” be high or low? Why?

Answer 1

Studies reveal that bank-specific factors play a considerable role in the determination of ‘interest- rate spreads’. These consist of bank size, return on average assets, credit risk as gauged by non-performing loans to overall loans ratio & operating expenses, all of which positively impact interest -rate spreads. On the other hand, greater bank liquidity ratio has an adverse impact on the spreads. On an average, large banks have greater spreads compared to the smaller ones . The effect of macroeconomic factors like actual economic growth is unimportant. The impact of the monetary strategy rate is positive but not very significant. The outcomes mainly reflect the banking sector's structure, in which a few large banks control a considerable market share.