Creative Commons

This dissertation was written as part of the MSc in Banking and Finance at the International Hellenic University. The primary purpose of this study is to examine the effect of falling interest rates and the interest rate spread to bank interest margins an d profitability in European Union. For this purpose, we examine an unbalanced sample of 29 11 banks from 19 European Union member states with annual frequency , for the period starting from 2010 until 2016. By using return on average assets and net interest margin as proxy for bank profitability, we find a strong positive significant relationship between net interest margin (NIM) and return on average assets (ROAA) on the one hand and short - term interest rates on the other, both in low and high interest rate regimes , as a drop of 1% in short term interest rates can reduce ROAA almost 21.7 basis points and NIM almost 35 basis points . The same results hold, although less strong for the interest spread as a drop of 1% in the interest rate spread can have a negati ve impact of almost 10 basis points in ROAA and NIM. In addition to that, we examine the effect of interest rates and spread to interest income margin and interest expense margin in order to explore the system from which the impact is transferred to net in terest margin. The results show that, in low interest rate regime , interest income margin absor b s large amount of the drop of interest rates, suggesting that banks have to reprice assets, but it is difficult to adjust liabilities, as they fear of losing their depositors.