Abstract:
Generally speaking, fi rms in developing countries face credit constraints, due in part to the
failure of fi nancial intermediaries to fulfi ll credit demands. Th us, a healthy credit expansion
can substantially improve the economic activity of such countries. Th is article investigates
the contribution that interest rates and the expansion of bank branch networks had on
the accumulation of deposits and available credit within the Sri Lankan fi nancial system,
based on quarterly statistics from 1990 to 2009. Th is article argues that the expansion
of bank branches positively contributes to the mobilization of deposits, resulting in the
creation of credit by the banking system. Moreover, as deposits are less sensitive to deposit
interest rates, banks can attempt to increase interest spreads by maintaining lower deposit
interest rates, as well implement the suggestions made within the fi nancial restraint model—
pioneered by Hellmann et al. (1997)—in order to capture the positive eff ect of interest
spread on the credit expansion.
Keywords: bank branches, credit, fi nancial development, fi nancial restraint, interest rates,
rent opportunities
Introduction
