This paper examines the optimal bank interest margin, the spread between the loan rate and the deposit rate of a bank, due to a debt crisis, sovereign debt in the bank's earning-asset portfolio is no longer safe. Under capital regulation, the bank's equity function is characterized by a down-and-out call option, with a structural break in volatility indicating a debt crisis. This research shows that the bank's interest margin is positively related to the structural break in volatility, and to the capital requirement.
