Interest Rate Pass-through Research Articles

Involuntary excess reserve and heterogeneous transmission of policy rates to bank lending rates in China

This study examines the impact of liquidity and involuntary excess reserves on interest rate pass-through in China. Employing Error Correction Model estimation based on a sample of 86 banks over the period of 2000–2013, the study finds that liquid banks can better shield against tightening monetary policy and adjust lending rate sluggishly. In contrast, banks with larger involuntary excess reserves tend to increase lending interest rates more rapidly in response to tightening monetary policy. We conclude that unwanted liquidity may lead to risk-taking behaviours which are detrimental to financial stability.

Zero Lower Bound on Deposit Rates and Transmission Mechanism of the Negative Interest Rate Policy

There have been heated debates on the negative interest rate policy (NIRP) since it was first introduced in major economies. Critics argue that deposit interest rates cannot break through the zero lower bound (ZLB) and that banks’ interest margins can be heavily squeezed under the NIRP. The underlying rationale is that deposits are the source of funding for banks. In this paper, we argue that in the modern credit money system, banks create deposits by making loans, and not the other way around. Deposit rates can be sufficiently negative without hurting banks’ profitability or curbing credit supply. We use a dynamic stochastic general equilibrium (DSGE) model to demonstrate the quantitative importance of ZLB on deposit rates in the transmission mechanism of monetary policy. Simulation results show that the ZLB on deposit rates heavily impede the transmission mechanism of the NIRP, which might explain the limited effects of the NIPR in the Euro Area and Japan. If banks are willing to expose retail depositors to negative interest rates, the effectiveness of the NIRP will be greatly strengthened and central banks should adopt deeply negative interest rates during a deflationary recession. The transmission mechanism of an NIRP has not been exactly the same as conventional interest rate cuts. Banks’ profitability is still a major concern, and the central banks that implement the NIPR only take modest action. Negative interest rates have not reached retail depositors and the effects of the NIRP are limited. We present a DSGE model to show that sticky deposit rates have impeded the transmission channel of the NIRP. This result explains the limited effects of the NIRP in Japan and the Euro Area. We challenge the prevailing view that banks cannot pass on negative policy rates to retail deposits. If the interest rate pass-through to deposit markets is complete, the NIRP is very effective in boosting credit growth and inflation. Given that natural interest rates in advanced economies have stayed low, central banks may resort to the NIPR more often in the future. When the ZLB is no longer a constraint, to raise the inflation target, as heatedly debated, is not a necessary move anymore.

The pass-through of monetary policy rate to lending rates: The role of macro-financial factors

This paper assesses how changes in the monetary policy rate affect the lending rates for the small and medium enterprise (SME), consumer, mortgage, and corporate loans in the Czech Republic—a high-income, OECD country. It further examines whether such interest rate pass-through is stable or could vary at different levels of bank competition, leverage, non-performing loans, and foreign exchange (FX) interventions. Using the co-integration approach, we find a significant and complete pass-through for SME lending rates. For consumer lending rates, we estimate the pass-through as unreliable. For both the mortgage and corporate rates, the pass-through shows significant structural shifts that can be entirely and largely explained by bank deleveraging. The markup for all lending rates, except for the corporate rates, increases with a growing spread between the government bond and monetary policy rates. FX interventions mostly affect the markups for corporate and SME rates.

Interest rate pass-through in the euro area: Financial fragmentation, balance sheet policies and negative rates

We examine interest rate pass-through in the euro area over the 2008–2016 period and investigate the effects of financial market fragmentation, European Central Bank balance sheet policies and negative rates on the nature of pass-through. We use heterogeneous panel cointegration methods and bank interest rates for four different loan categories: small and large firm loans, housing loans and consumer loans. We find that interest rate pass-through is complete only for small firm loans; it is thus incomplete for other loan categories. Our results suggest that while interest rate pass-through has been weakened by higher sovereign credit risk, the European Central Bank's balance sheet policies helped curb these adverse effects on pass-through. Lower financial market fragmentation translated into lower lending rates. In addition, we fail to find evidence that bank interest rates became less responsive to market rates when market rates became negative.

Transmission Mechanism of Monetary Policy: Case Study of Interest Rate Channel in India

In India, prior to 1991, the tightly controlled interest rates caused impediments in the functioning of the interest rate channel of monetary policy transmission while after 1991, the RBI undertook various measures to strengthen the market-determination of interest rates. This paper has examined the evolution of the interest channel in India across the period 1985 to 2014 firstly by studying the interest rate pass-through using the Correlation matrix and the OLS technique and secondly, by studying the transmission of policy rates to the real economy using the reduced VAR model. The results show that the transmission of interest rates pass-through from policy rates to market interest rates (both - short-term as well as long-term) has strengthened while desired impact of long term market interest rates on industrial production and inflation appears to be weak.

Interest Rate Pass-Through: Empirical Study Towards Monetary Policy Transmission Effectiveness in Indonesia

<p><em>This research aims to measure the effectiveness of monetary policy transmission, especially through the interest rate channel. The analysis was conducted on the first stage of its transmission, namely Interest Rate Pass-through (IRPT). IRPT refers to condition in which retail interest rate (both deposit and lending rate) responds to changes in policy rate of central bank. IRPT was measured using Error Correction Model (ECM) for time series data in the period of January 2010 - December 2015. The results of this study indicated that degree of long term and short term IRPT is incomplete for deposit and lending rate. In addition, IRPT for deposit rate is higher than lending rate, but the adjustment process of lending rate faster than deposit rate. Finally, model that include other variables (macroeconomic and internal banking indicator) generate long term IRPT which is smaller than the standard model. This results implies that the Central Bank, the FSA, and government needs to pay attention to the stability of the other variables that may interfere or reduce the effectiveness of monetary policy through the interest channel. </em></p><p><strong><em>JEL Classification: </em></strong>E42, E43, E52</p><strong><em>Keywords: </em></strong><em>Deposit rate, ECM, IRPT, Lending Rate, Policy Rate</em>

The Role of Non-Performing Loans for Bank Lending Rates

Against the backdrop of a high stock of non-performing loans (NPLs) in several European countries, this paper investigates the role of NPLs for lending rates charged for newly granted loans in the euro area. More precisely, it looks for an effect that extends beyond losses caused by that stock which have already been incorporated into the banks' capital positions. The paper focuses on the question of which channels are responsible for such a potential effect. The results indicate that a higher stock of net NPLs is associated with higher lending rates, whereby there are indications that this relation tends to be offset by loan loss reserves. Although the NPL stock affects banks' idiosyncratic funding costs as well, the latter do not seem to constitute an important link between the stock of NPLs and lending behavior. Furthermore, NPLs do not strongly affect the banks' interest rate pass-through.

Interest Rate Pass-Through in Pakistan: Evidence from the Asymmetric Co-integration Approach

This study examines the asymmetry of interest rate pass-through between wholesale (KIBOR) and retail interest rates (Deposit and Lending rate) for Pakistan, by using the asymmetric threshold co-integration proposed by Enders & Sikles (2001) and EC-EGARCH-M model proposed by Wang & Lee (2009). Empirical results of threshold co-integration test confirm that asymmetric relation exists between wholesale and retail interest rates, and hence the rate of pass-through is incomplete. Furthermore, in the long-run, retail interest rates are rigid towards the downwards adjustment, and hence there is an upward adjustment in error correction mechanism.

Interest rate pass-through in Turkey during the period of unconventional interest rate corridor

After adopting new monetary policy framework at the end of 2010, the Central Bank of the Republic of Turkey (CBRT) started actively using both multiple short-term policy rates and funding composition over the banks in order to manage the liquidity requirement of the banking system. In this regard, this paper examines interest rate pass-through from multiple policy rates to the retail rates in Turkey and explores asymmetries in the adjustment process within the framework of an asymmetric ARDL model developed by Shin et al. (2014). Our findings revealed that both the CBRT average funding rate and interbank repo rate play an important role rather than official policy rates (weekly repo rate, overnight lending rate, overnight borrowing rate, and late liquidity rate) in this new policy framework. Our results also captured greater pass-through to the interest rate of commercial loans than the interest rate of consumer loans and banking deposits. Moreover, all retail rates respond faster to policy rate cuts than hikes, indicating that the banks were reluctant to raise interest rates than to decrease during the period under investigation.

Interest Rate Pass-Through to the Rates of Core Deposits: A New Perspective

Within a Salop framework, this paper shows that banks' profit smoothing can explain incomplete pass-through of market rates to the rates of core deposits. Using time series data of deposit and lending rates of local German banks, this paper will show that local banks pass through return variations to their depositors. To the degree to which market rates influence new business lending rates, there is, therefore, an indirect channel through which market rates affect the rate of core deposits. In the absence of capital market alternatives for core deposits, this indirect channel explains why changes in the market rate affect the rate of core deposits only slowly and fractionally.

Monetary Policy Transmission in the Eastern Caribbean Currency Union

This paper empirically investigates international and domestic monetary policy transmission mechanisms in the Eastern Caribbean Currency Union (ECCU). We assess interest rate pass-through of both the U.S. policy rate and the ECCU minimum saving deposit rate (MSR) into domestic interest rates through the interest rate channel. While economic theory suggests that the international pass-through should be high in small open economies with fixed exchange rates and open capital accounts, our findings, based on regression analysis, point to a low long-run pass-through coefficient of the U.S. interest rate. The domestic transmission channel, however, is found to operate through changes in the MSR. The results hold for different interest rates (deposit and lending) and are supported by survey-based findings.

Monetary Policy Transmission in the Eastern Caribbean Currency Union

This paper empirically investigates international and domestic monetary policy transmission mechanisms in the Eastern Caribbean Currency Union (ECCU). We assess interest rate pass-through of both the U.S. policy rate and the ECCU minimum saving deposit rate (MSR) into domestic interest rates through the interest rate channel. While economic theory suggests that the international pass-through should be high in small open economies with fixed exchange rates and open capital accounts, our findings, based on regression analysis, point to a low long-run pass-through coefficient of the U.S. interest rate. The domestic transmission channel, however, is found to operate through changes in the MSR. The results hold for different interest rates (deposit and lending) and are supported by survey-based findings.

The New Area-Wide Model II: An Extended Version of the ECB’s Micro-Founded Model for Forecasting and Policy Analysis with a Financial Sector

This paper provides a detailed description of an extended version of the ECB’s New Area-Wide Model (NAWM) of the euro area (cf. Christoffel, Coenen, and Warne 2008). The extended model—called NAWM II—incorporates a rich financial sector with the threefold aim of (i) accounting for a genuine role of financial frictions in the propagation of economic shocks and policies and for the presence of shocks originating in the financial sector itself, (ii) capturing the prominent role of bank lending rates and the gradual interest-rate pass-through in the transmission of monetary policy in the euro area, and (iii) providing a structural framework useable for assessing the macroeconomic impact of the ECB’s large-scale asset purchases conducted in recent years. In addition, NAWM II includes a number of other extensions of the original model reflecting its practical uses in the policy process over the past ten years. JEL Classification: C11, C52, E30, E37, E58

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

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.

The Transmission Mechanism of Russian Central Banks Countercyclical Monetary Policy since 2011: Evidence from the Interest Rate Pass-Through

The study is an investigation of the nature of the Russian interest rate pass-through from February 2011 to November 11, 2016. The empirical results reveal a relatively low short-run interest pass-through of 0.662937 and an incomplete long-run interest rate pass-through of 0.826353. The bounds test results indicate no long-term relationship between countercyclical monetary policy and market rates. These empirical findings suggest that the Russian Central Bank has not been very effective in formulating and implementing its countercyclical monetary policy. In light of the formidable political and economic challenges faced by the Russian Federation over this sample period, the results are hardly surprising.

Interest Rate Pass-Through: Mortgage Rates, Household Consumption, and Voluntary Deleveraging

Exploiting variation in the timing of resets of adjustable-rate mortgages (ARMs), we find that a sizable decline in mortgage payments (up to 50 percent) induces a significant increase in car purchases (up to 35 percent). This effect is attenuated by voluntary deleveraging. Borrowers with lower incomes and housing wealth have significantly higher marginal propensity to consume. Areas with a larger share of ARMs were more responsive to lower interest rates and saw a relative decline in defaults and an increase in house prices, car purchases, and employment. Household balance sheets and mortgage contract rigidity are important for monetary policy pass-through. (JEL D12, D14, E43, E52, G21, R31)

How Strong and Fast Were the Low Interest Rates Passed on to Bank Customers in Germany?

In this paper it is shown that the ECB’s main refinancing rate, measured by various Taylor-rules, has for the past decade been far too low for Germany. That entails risks for the stability of Germany’s financial system. How strong these risks materialise depends on the extent to which German banks pass on the low policy rates to their customers. In this paper, the interest rate pass-through in Germany in the low interest era is investigated using error-correction models for various bank interest rates. The results indicate a stronger short-term pass-through as well as diminished interest rate margins that weigh on banks’ profits. However, there is no evidence for structural changes in the long-term relationship between policy rates and banks’ interest rates. While the latter might be soothing for monetary policy makers, the former is rather a reason for concern.

ANALISIS INTEREST RATE PASS-THROUGH PADA MEKANISME TRANSMISI KEBIJAKAN MONETER INDONESIA

This reseach aimed to evaluate the performance of monetary policy, toexamine and test the magnitude of the response rates on deposits and bank loans to the money market interest rate, and how fast adjustment of the interest rate of deposits and loans in response to changes in money market interest rates. The performance evaluation of the level of adjustment of interest rate pass-through is done by testing the coefficient of adjustment of the interest rate deposits and loans in response to changes in money market interest rates. The object of this reseach is reported in interest rates interbank money market (rPUAB) and bank interest rates (loans and deposits) of all commercial banks in Indonesia, the data used in the form of a row of monthly time (monthly time series) of the annual report of Bank Indonesia and SEKI ( Economic and Financial statistics Indonesia), in the period 2005-2016. The method used in this research is the Autoregressive Distributed Lag (ARDL) for calculating the amount of long-term coefficients and Error Correction Model (ECM) -ARDL for calculating the amount of short-term coefficients. We find of the analysis indicate a change of monetary policy in the short term through the interest rate channel with its operational targets interest rates interbank money market (interbank) did not respond in full by the rates on deposits and loans in commercial banks in Indonesia, represented by the value of the degree of pass- through which less than 1 and there is a tendency that the longterm interest rates on loans and deposits experienced incomplete pass-through, then interest rates on consumer loans and deposits of 24 months has the speed of the slowest, which means consumer loans and deposits of 24 months in Indonesia unresponsive to changes in interbank rates. keywords: ARDL, ECM, Interest Rate pass-through, PUAB.

The Mexican Interest Rate Pass-Through in the Post-U.S. Subprime Mortgage Crisis Era

ABSTRACTThis study investigates the nature of the Mexican interest rate pass-through during the post-U.S. subprime mortgage crisis. The empirical results reveal a very high short-run and an almost complete long-run interest rate pass-through. The bounds test indicates a long-term relationship between countercyclical monetary policy and market rates. Notwithstanding the rigid inflation targeting set by the Mexican Central Bank in the very concentrated Mexican market and its openness to foreign competition, the Mexican open economy is very small compared to the U.S. economy. Despite these conditions, the Mexican Central Bank has been very effective in conducting its countercyclical monetary policy.

Interest rate pass-through: a nonlinear vector error-correction approach

Abstract This paper analyzes pass-through from money market rates to consumer retail loan and deposit rates in Canada from 1983 to 2015 using a nonlinear vector error-correction model. This model permits estimation of long-run pass-through coefficients while simultaneously accounting for asymmetric adjustments and short-run dynamics. In contrast to empirical frameworks used in previous studies, it also allows testing of commonly made assumptions such as exogeneity of the market rate, making inference more robust. I find that pass-through was complete for all rates before the financial crisis although only after the mid 1990s for the 1 year mortgage rate. Since the end of the 2008–2009 recession, pass-through remains complete in the mortgage market but has significantly declined for deposit rates. Furthermore, many rates adjust asymmetrically but the direction of rigidity differs among rates and time periods.