and cash reserve holdings (-9bps) by banks. It also points out that stable macroeconomic conditions have been conducive to reducing costs of bank financial intermediation through inflation (-5bps) and interest rate (-3bps) channels.

Our empirical exercise also highlights that high credit concentration (as indicated by size of operations, +51bps), relatively low price competition (as measured by Lerner index, +12bps), and relatively weak environment of contract enforcement (as proxied by recovery rate, +11bps) can be areas worthwhile of consideration when policies to improve banking intermediation efficiency are designed.

# **6. Conclusions**

The costs of financial intermediation have important consequences for financial development, including financial deepening and financial inclusion. Based on a comprehensive cross-country data set with banklevel data, this paper analyzed net interest margin determinants around the world. First, we use an accounting decomposition framework to provide summary statistics on the size of net interest margins and to highlight its cost and profit components in countries, regions and income groups. Second, we use regression analysis to examine underlying bank-level, structural, macroeconomic and institutional determinants of net interest margins. Finally, we use the results of our econometric analysis to illustrate the relative contribution of each variable, so as to provide guidance on key areas of structural reforms to reduce the costs of financial intermediation.

We broadly confirm findings of previous research. The analysis provides evidence that the costs of financial intermediation are negatively associated with income levels: net interest margins are significantly higher in lower income countries. On the other hand, a regional focus shows that costs of financial intermediation are especially high in Latin America and Sub-Saharan Africa. Accounting decomposition of intermediation spreads indicates that higher margins in low income economies, Latin America and Sub-Saharan Africa are mostly explained by higher overhead (probably reflecting low economies of scale and low productivity), higher credit risk (which may reflect a weaker environment) and greater bank profitability (which may be due to low market competition).

The econometric analysis highlights that all variables have the expected impact on net interest margins, with magnitude conditional upon levels of economic development. Higher intermediation spreads are significantly associated with larger operations, higher risk aversion, higher opportunity costs arising from reserve requirements, higher overhead, higher credit risk, lower competition, higher interest rate risk and higher inflation. In general, the impact of these variables is stronger in less wealthy economies. Finally, we find suggestive evidence that a relatively underdeveloped credit infrastructure negatively affects net interest margins across countries: deficiencies in the contractual and information frameworks are associated with higher intermediation spreads.

The bar-charts of relative contributing factors to financial intermediation costs, which are constructed using a decomposition of the difference between each country’s net interest margin and the average banking system in the world, help visualize deficiencies and focus policy makers’ attention. While the usefulness of the bar-charts is to highlight country-level areas of focus, some interesting patterns emerge. Market-developing policies aimed at addressing deficiencies in the contractual and information frameworks and at maintaining macroeconomic stability can have important repercussions for the costs of financial intermediation in lower income economies and should be the main concern of policy makers in these countries. These policies should be complemented by market-enabling policies aimed at increasing contestability in the banking system, and by policies aimed at promoting technological innovation in the production and distribution of banking services to reduce overhead and increase 14