An Empirical Study on the Determinants of the Cost of Financial Intermediation in the Korean Banking Industry(Vol.9 No.1)
This paper examines the determinants of the cost of financial intermediation using Korean bank data from 1992 through 2004.
I find strong evidence that the diversification of banking activities decreases the cost, indicating that pursuing it is a desirable direction not only for a bank's profit maximization but for effective financial intermediation in the economy. Unlike the theoretical expectation, bank size and bank concentration do not seem to affect the cost of financial intermediation. The bank size, however, seems to have become a critical factor since the financial crisis in 1997, though the sign is ambiguous.
The credit risk turns out to adversely affect the cost, suggesting that an improvement in credit-rating skills is required for effective financial intermediation. The equity ratio is analyzed as not affecting the cost, raising doubt as to the existence of market discipline through deposit interest rates in the Korean banking industry.
Meanwhile interest rate risk shows a positive sign, but it is insignificant. Since banks, however, are becoming more sensitive to the volatility of interest rates, the monetary authorities should seek to minimize it while implementing monetary policy.