How bank business models drive interest margins: evidence from US bank-level data

The two decades prior to the credit crisis witnessed a strategic shift from a traditional, relationships-oriented model (ROM) to a transactions-oriented model (TOM) of financial intermediation in developed countries. A concurrent trend has been a persistent decline in average bank interest margins. In the literature, these phenomena are often explained using a causality that runs from increased competition in traditional segments to lower margins to new activities. Using a comprehensive data set with bank-level data on over 16,000 Federal Deposit Insurance Corporation-insured US commercial banks for a period ranging from 1992 to 2010, this paper qualifies this chain of causality. We find that a bank's business model, measured using a multi-dimensional proxy of relationship banking activity, exerts a strong, positive effect on interest margins. Our results suggest that the strategic shift from ROM to TOM has transformed banks’ balance sheets and reduced interest rate margins as a by-product.