Dynamics of Lending Rates in the Baltic Countries: Influence of Funding Costs of Banks and Risk Factors

Abstract

In the Baltic countries, lending rates have been among the highest in the euro area mainly reflecting national differences in the market structure as well as relatively strict credit standards applied by banks in response to the changes in their perception of risk. In this context, the deeper econometric analysis could provide additional information about the common and diverging aspects of the dynamics of lending rates in the Baltic countries. Therefore, the aim of the paper to explore the pass-through of funding costs of banks to lending rates in different lending segments in the Baltic countries during the period of 2005–2015 taking in account risk considerations. To reach the set aim, appropriate comparisons are made between different specifications of the error correction model, first of all, relating specifications with 3-month EURIBOR rate and weighted average costs of short-term euro liabilities and, secondly, specifications with and without the measures of borrower credit risk and banking risk. As a result, the conclusion was reached about superiority of 3-month EURIBOR rate as a measure of funding costs of banks. The measures characterising creditworthiness of borrowers and banking risk are significant factors determining lending rates in the Baltic countries. Across the Baltic States, the pass-through from funding costs of banks to lending rates is high. Long-term pass-through from funding costs of banks to lending rates tends to be higher in Lithuania, but creditworthiness of borrowers appeared to have the highest influence on lending rates in Latvia.