The Pass-Through from Market Interest Rates to Bank Lending Rates in Germany

Abstract

The terms and conditions on which bank loans are made to non-financial firms and households play a key role in the transmission of monetary policy. This paper analyses the relationship between German bank lending rates and both money market and capital market rates in the 1990s. This study reveals evidence of structural differences in the interest rate pass-through across German banks. The speed at which bank lending rates adjust to changes in market rates is related to a credit institution's size, its refinancing conditions and the extent of its business with non-banks. Large banks and banks with few savings deposits adjust their lending rates to market terms more quickly than other banks, possibly because their scope for setting interest rates is comparatively narrow. A fairly small amount of long-term business with non-bank customers, indicating the importance of relationship banking, also leads to a faster lending rate pass-through. In the short run, lending rates are stickier for banks that are largely able to cover their long-term loans to non-banks by corresponding deposits from such clients. Finally, the lending rates charged on corporate loans at a number of banks – especially those for current account credit – respond only gradually to changes in market rates. By smoothing their rates, banks appear to accept temporary fluctuations in their loan mark-up. This, in turn, tends to retard monetary policy transmission via bank rates. In the long-run relationship between lending and market rates, however, apart from a constant bank-specific mark-up, there are, in most cases, no differences across banks. This suggests that a similar long-run pass-through obtains for all interest rate reporting banks, irrespective of the adjustment process.