Measuring bank funding costs in the analysis of interest rate pass-through: Evidence from Poland

Abstract

Literature offers different explanations of the increase in lending spreads and limited impact of monetary policy on lending rates since the global financial crisis: worsened bank funding conditions, higher perceived risk and the need to improve capital position. However, the empirical assessment of their relative relevance seems still insufficient. Therefore we investigate the determinants of lending rates using bank-level panel data by including all the above factors in empirical analysis of the interest rate pass-through. In particular, to better capture a relative increase in banks' funding costs we calculate a weighted average cost of liabilities and use it instead of a money market interest rate in testing how banks set lending rates. In contrast to the money market rate – usually employed in interest rate transmission analyses – the weighted average cost of liabilities comprises interest rates on many sources of banks' funding and is sensitive to changes in structure of banks' liabilities. Our findings imply that money market interest rates may not be a sufficiently good proxy for banks' funding costs, especially in the periods of increased financial stress and for analyses of the transmission of negative interest rates. In this way the paper offers a new analytical perspective on analyzing monetary transmission mechanism in the banking sector.