statistics), and estimate the sensitivities of net interest margins with respect to dependent variables, as specified in equation (4).<sup>3</sup> Let xi,j,t denote a variable for bank i in country j and year t. At the country-level, this variable is represented as xj, the average generated for j over i and t. Then, we use the mean mx and standard deviation sx of xj to measure the cross-country central tendency and dispersion of x. The dependent variable, as well as bank-level, macroeconomic, structural, and institutional variables are standardized as �xi,j,t–mx�/sx for the regressions. This procedure allows the estimated coefficients to be interpreted as the standard deviation change in the net interest margin per one standard deviation change in the independent variable.

We first consider bank-level variables: size of operations, risk aversion, opportunity cost of bank reserves, operating costs, credit risk, and income diversification (Table 4a, column 1). The results show that banks with larger operations charge a higher margin, suggesting that any potential benefit arising from economies of scale is offset by higher risk, since for a given value of credit and market risk larger operations are expected to translate into a higher potential loss, for which banks demand a risk premium. We also find that more risk averse and better capitalized banks require higher margins, consistently with theory and previous empirical evidence. This can be explained by the reluctance of risk-averse banks to engage in more profitable but riskier lending activities. Our results also show that reserve requirements are a monetary or regulatory policy tool that could affect the cost of intermediation. Its proxy, the opportunity cost of bank reserves variable, is positively and significantly associated with spreads. Higher reserve requirements are translated into higher interest spreads to compensate for the missing incomes resulting from zero or low return on reserves.

Next, we turn to operating costs. As expected, less efficient banks operating with higher costs charge higher margins, passing onto depositors and borrowers their higher overhead. As expected, higher credit risk is also associated with higher margins, as banks require higher profits to compensate for risk, and this effect is stronger in wealthier countries. Finally, as predicted by theoretical models, the noninterest income variable has a negative and significant effect, showing that banks engaging more in non-lending activities have lower intermediation spreads. This may reflect a strategy of cross-subsidization with traditional activities (see Carbó Valverde and Rodriguez, 2007; and Lepetit et al., 2008). For example, banks may reduce lending rates to borrowers who also use other bank services, generating fees and commissions such as payment services or underwriting of securities.

Table 4a, column 2, evaluates the impact of macroeconomic and structural variables. The results show that macroeconomic and competitive conditions do affect net interest margins. Bank net interest margins increase with inflation, suggesting that macroeconomic instability creates uncertainty to which banks respond by lifting margins upward. We also find that the volatility in the money market rate is positive and significant: banks respond to increased uncertainty in benchmark rates by raising spreads. However, interest rate risk is not significant at standard confidence intervals. We finally find that the Lerner index, our measure of market competition, enters positively and significantly, suggesting that banks commanding market power can charge higher lending rates and offer lower deposit rates, resulting in higher costs of financial intermediation.

Table 4a, columns 3-4, evaluates the impact of institutional variables when controlling for bank-level and country-level macroeconomic and structural variables. Though the coefficients for the institutional

> 3 The estimations are based on a sample of 128 countries on which all specifications can be implemented to arrive at fully comparable coefficient estimates.

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