The Impact of Indirect Competition on Bank Net Interest Margins: Microfinance Evidence from Pakistan

Abstract

The study aims to investigate the impact of growth in microfinance initiatives on the net interest margins of commercial banks in Pakistan. Using data from the world bank MIX database and Thomson Reuters, we conducted a GLS random effect estimation on an unbalanced panel of Pakistani banks from 2010 to 2018. We find that credit quality, solvency, bank size, earning asset diversification, and market concentration impact banks' net interest margins. In addition, we find growth in development finance institutions to significantly affects commercial bank margins. Microfinance institutional growth is found to reduce net interest margins. Besides microfinance institutions, the growth of specialised microfinance banks is also found to impact the spread negatively. This indirect effect may be evidence of the improved efficiency derived from higher competition or the fact that microfinance institutions may be using conventional banks as a permanent source of funds to become financially sustainable. The role of microfinance growth is not considered in literature since microfinance institutions are very different from conventional banks regarding lending volume and size. This study contributes to the existing theoretical and empirical literature on net interest margins by showing a positive role of indirect competition on banks' net interest margins. Therefore, policymaking focusing on improving conditions that enhance competition to bring bank spreads closer to regional levels may be needed.