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Abstract

We develop a dynamic model of the interest rates of a monopolistic bank, providing both intermediation and payment services. We obtain testable restrictions on portfolio separation from the dynamic terms of the reduced-form solutions, and test the model using balance-sheet data from large banks of 17 OECD countries, over the period 1988–2007. We find strong evidence against the portfolio separation hypothesis. In line with the predictions of the model, interest margins rise with higher market interest rates, lower revenues from fees, and higher industrial costs and loan loss provisions.