The Provision of Services, Interest Margins and Loan Pricing in European Banking

Abstract : This paper assesses the implications on bank interest margins of the expansion into non- traditional fee-based activities in European banking. We use a sample of 602 European commercial and cooperative banks from 1996 to 2002 and consider the total income shares of trading income and commission and fee income as measures of product diversification to explore loan pricing. Our results show that a higher income share from commission and fee activities is associated with lower margins and lower lending rates but that there is no link with trading activities. For banks exhibiting a higher share of commission and fee income there is a weaker link between the rate they charge on loans and borrower default risk. The hypothesis that banks use loans as a loss leader altering default screening and monitoring activities and consequently risk pricing cannot be rejected.