Economics and Business
ISSN 2775-9237 (Online)
Published: 06 June 2022
The Role of Financial Structural Factors in Retail Rate Adjustment: Evidence from Sri Lanka
Central Bank of Sri Lanka, Sri Lanka
Download Full-Text Pdf
Keywords: Bank Retail Rates, Financial Structural Factors, Interest Rate Pass-Through, Monetary Policy
This paper examines the interest rate channel of monetary policy transmission. It assesses the impact of banking structural factors on commercial bank pricing decisions and their pass-through in Sri Lanka. The empirical analysis uses aggregate monthly interest rates data from January 2008 to December 2018, a total of 132 observations. The findings suggest that the interest rate pass-through is significant overall, but incomplete. The credit quality, operational efficiency and excess liquidity play essential roles in explaining the adjustments of the bank lending and deposit rates. Non-performing loans increase the lending rate, and this result is robust to different combinations of the control variables. This suggests that banks with higher proportions of non-performing loans attempt to pass their credit losses on to customers. Further, bank inefficiency is passed on to customers in the form of lower deposit rates and excess liquidity in the banking system, both of which have a negative effect on the interest rate adjustments of both lending and deposit rates. A puzzling negative relationship is observed between the lending rate and operational inefficiency. The findings of this paper support the claim that banks in Sri Lanka take into consideration their structural factors as well as the monetary policy rates when setting the lending and deposit rates.
Agénor, P-R & El Aynaoui, K 2010, 'Excess liquidity, bank pricing rules, and monetary policy', Journal of Banking & Finance, vol. 34, no. 5, pp. 923-933.
Allen, F, Carletti, E & Gale, D 2009, 'Interbank market liquidity and central bank intervention', Journal of Monetary Economics, vol. 56, no. 5, pp. 639-652.
Amarasekara, C 2005, 'Interest rate pass-through in Sri Lanka', Staff Studies, Central Bank of Sri Lanka, vol. 35, no. 1, pp. 1-32.
Andrews, DW 1993, 'Tests for parameter instability and structural change with unknown change point', Econometrica: Journal of the Econometric Society, vol. 61, no. 4, pp. 821-856.
Andrews, DW 2003, 'Tests for parameter instability and structural change with unknown change point: A corrigendum', Econometrica, vol. 71, no. 1, pp. 395-397.
Bai, J & Perron, P 1998, 'Estimating and testing linear models with multiple structural changes', Econometrica, vol. 66, no. 1, pp. 47-78.
Becker, R, Osborn, DR & Yildirim, D 2012, 'A threshold cointegration analysis of interest rate pass-through to UK mortgage rates', Economic Modelling, vol. 29, no. 6, pp. 2504-2513.
Bennouna, H 2018, 'Interest rate pass-through in Morocco: Evidence from bank-level survey data', Economic Modelling, vol. 80, no. 5, pp. 142-157.
Berger, AN 1995, 'The profit-structure relationship in banking--tests of market-power and efficient-structure hypotheses', Journal of Money, Credit and Banking, vol. 27, no. 2, pp. 404 -431.
Bernanke, BS & Gertler, M 1995, 'Inside the black box: the credit channel of monetary policy transmission', Journal of Economic perspectives, vol. 9, no. 4, pp. 27-48.
Bikker, JA & Gerritsen, DF 2018, 'Determinants of interest rates on time deposits and savings accounts: macro factors, bank risk, and account features', International Review of Finance, vol. 18, no. 2, pp. 169-216.
Boone, J & Van Leuvensteijn, M 2010, 'Measuring competition using the profit elasticity: American sugar industry, 1890-1914', Discussion Paper Series , Tjalling C. Koopmans Research Institute, vol. 10, no. 2, pp. 56-87.
Borio, C, Gambacorta, L & Hofmann, B 2017, 'The influence of monetary policy on bank profitability', International Finance, vol. 20, no. 1, pp. 48-63.
Borio, CE & Fritz, W 1995, 'The response of short-term bank lending rates to policy rates: a cross-country perspective', BIS Working Papers, vol. 27.
Byrne, D & Kelly, R 2019, 'Bank asset quality & monetary policy pass-through', Applied Economics, vol. 51, no. 23, pp. 2501-2521.
Central Bank of Sri Lanka 2016, Annual Report, Colombo, Sri Lanka.
Coricelli, F, Égert, B & MacDonald, R 2006, 'Monetary transmission in central and eastern Europe: gliding on a wind of change', Focus on European Economic Integration, vol. 1, no. 06, pp. 44-87.
Cottarelli, C & Kourelis, A 1994, 'Financial structure, bank lending rates, and the transmission mechanism of monetary policy', IMF Staff Papers, vol. 41, no. 4, pp. 587-623.
De Bondt, GJ 2005, 'Interest rate pass‐through: empirical results for the Euro Area', German Economic Review, vol. 6, no. 1, pp. 37-78.
De Graeve, F, De Jonghe, O & Vander Vennet, R 2007, 'Competition, transmission and bank pricing policies: Evidence from Belgian loan and deposit markets', Journal of Banking & Finance, vol. 31, no. 1, pp. 259-278.
Demirgüç-Kunt, A & Huizinga, H 2010, 'Bank activity and funding strategies: The impact on risk and returns', Journal of Financial Economics, vol. 98, no. 3, pp. 626-650.
Egert, B, Crespo-Cuaresma, J & Reininger, T 2007, 'Interest rate pass-through in central and Eastern Europe: Reborn from ashes merely to pass away?', Journal of Policy Modeling, vol. 29, no. 2, pp. 209-225.
Fuertes, AM & Heffernan, SA 2009, 'Interest rate transmission in the UK: A comparative analysis across financial firms and products', International Journal of Finance Economics, vol. 14, no. 1, pp. 45-63.
Gambacorta, L 2008, 'How do banks set interest rates?', European Economic Review, vol. 52, no. 5, pp. 792-819.
Gambacorta, L, Illes, A & Lombardi, MJ 2015, 'Has the transmission of policy rates to lending rates changed in the wake of the global financial crisis?', International Finance, vol. 18, no. 3, pp. 263-280.
Gambacorta, L & Mistrulli, PE 2014, 'Bank heterogeneity and interest rate setting: what lessons have we learned since Lehman Brothers?', Journal of Money, Credit and Banking, vol. 46, no. 4, pp. 753-778.
Gerlach, S & Svensson, LE 2003, 'Money and inflation in the euro area: a case for monetary indicators?', Journal of Monetary Economics, vol. 50, no. 8, pp. 1649-1672.
Gigineishvili, MN 2011, Determinants of interest rate pass-through: Do macroeconomic conditions and financial market structure matter?, International Monetary Fund.
Gopalan, S & Rajan, R 2017, 'Does foreign bank presence affect interest rate pass-through in emerging and developing economies?', Journal of Macroeconomics, vol. 54, no. 3, pp. 373-392.
Gregor, J & Melecký, M 2018, 'The pass-through of monetary policy rate to lending rates: The role of macro-financial factors', Economic Modelling, vol. 73, no. 5, pp. 71-88.
Grigoli, F & Mota, JM 2017, 'Interest rate pass-through in the Dominican Republic', Latin American Economic Review, vol. 26, no. 1, pp. 41-66.
Gual, J 1999, 'Deregulation, Integration, and market structure in European Banking', Journal of the Japanese international economies, vol. 13, no. 4, pp. 372-396.
Ho, TS & Saunders, A 1981, 'The determinants of bank interest margins: theory and empirical evidence', Journal of Financial and Quantitative analysis, vol. 16, no. 4, pp. 581-600.
Hofmann, B & Mizen, P 2004, 'Interest Rate Pass‐Through and Monetary Transmission: Evidence from Individual Financial Institutions' Retail Rates', economica, vol. 71, no. 281, pp. 99-123.
Horváth, C, Krekó, J & Naszódi, A 2004, 'Interest rate pass-through: the case of Hungary', National Bank of Hungary Working Paper, vol. 8.
Illes, A, Lombardi, M & Mizen, P 2015, 'Why did bank lending rates diverge from policy rates after the financial crisis?', BIS Working Papers 486, Bank for International Settlements.
Kashyap, AK & Stein, JC 2000, 'What do a million observations on banks say about the transmission of monetary policy?', American Economic Review, vol. 90, no. 3, pp. 407-428.
Leroy, A & Lucotte, Y 2016, 'Structural and cyclical determinants of bank interest-rate pass-through in the Eurozone', Comparative Economic Studies, vol. 58, no. 2, pp. 196-225.
Leroy, H, Anseel, F, Gardner, WL & Sels, L 2015, 'Authentic leadership, authentic followership, basic need satisfaction, and work role performance: A cross-level study', Journal of management, vol. 41, no. 6, pp. 1677-1697.
Liu, M-H, Margaritis, D & Tourani-Rad, A 2008, 'Monetary policy transparency and pass-through of retail interest rates', Journal of Banking & Finance, vol. 32, no. 4, pp. 501-511.
Maudos, Jn & De Guevara, JF 2004, 'Factors explaining the interest margin in the banking sectors of the European Union', Journal of Banking & Finance, vol. 28, no. 9, pp. 2259-2281.
McNown, R, Sam, CY & Goh, SK 2018, 'Bootstrapping the autoregressive distributed lag test for cointegration', Applied Economics, vol. 50, no. 13, pp. 1509-1521.
Mishkin, FS 1995, 'Symposium on the monetary transmission mechanism', Journal of Economic perspectives, vol. 9, no. 4, pp. 3-10.
Mojon, B 2000, 'Financial structure and the interest rate channel of ECB monetary policy', ECB Working Paper.
Ozdemir, BK 2009, 'Retail bank interest rate pass-through: the Turkish experience', International Research Journal of Finance and Economics, vol. 1, no. 28, pp. 52-76.
Pariès, MD, Moccero, D, Krylova, E & Marchini, C 2014, 'The retail bank interest rate pass-through: The case of the euro area during the financial and sovereign debt crisis', Occasional Paper series, ECB, vol. 155, no. 2, pp. 26-30.
Perera, A 2016, 'Monetary Transmission Mechanism in Sri Lanka: A Comprehensive Assessment with New Evidence', Staff Studies, vol. 43, no. 1-2, pp. 63-107.
Pesaran, MH & Shin, Y 1999, An autoregressive distributed-lag modelling approach to cointegration analysis. Econometrics and economic theory in the 20th century: the Ragnar Frisch Centennial Symposium, Cambridge University Press, Cambridge.
Pesaran, MH, Shin, Y & Smith, RJ 2001, 'Bounds testing approaches to the analysis of level relationships', Journal of applied econometrics, vol. 16, no. 3, pp. 289-326.
Rousseas, S 1985, 'A markup theory of bank loan rates', Journal of Post Keynesian Economics, vol. 8, no. 1, pp. 135-144.
Sam, CY, McNown, R & Goh, SKJEM 2019, 'An augmented autoregressive distributed lag bounds test for cointegration', Economic Modelling, vol. 80, no. 4, pp. 130-141.
Sander, H & Kleimeier, S 2004, 'Convergence in euro-zone retail banking? What interest rate pass-through tells us about monetary policy transmission, competition and integration', Journal of International Money and Finance, vol. 23, no. 3, pp. 461-492.
Schlüter, T, Busch, R, Hartmann-Wendels, T & Sievers, S 2012, 'Determinants of the interest rate pass-through of banks: Evidence from German loan products', Disscussion Paper, Deutsche BundeshBank, vol. 26, pp. 163-187.
Sørensen, CK & Werner, T 2006, Bank interest rate pass-through in the euro area: a cross country comparison, ECB working paper.
Stiglitz, JE & Weiss, A 1981, 'Credit rationing in markets with imperfect information', The American economic review, vol. 71, no. 3, pp. 393-410.
Van Leuvensteijn, M, Bikker, JA, Van Rixtel, AA & Sørensen, CK 2011, 'A new approach to measuring competition in the loan markets of the euro area', Applied Economics, vol. 43, no. 23, pp. 3155-3167.
Van Leuvensteijn, M, Sørensen, CK, Bikker, JA & Van Rixtel, AA 2013, 'Impact of bank competition on the interest rate pass-through in the euro area', Applied Economics, vol. 45, no. 11, pp. 1359-1380.
Wang, K-M & Lee, Y-M 2009, 'Market volatility and retail interest rate pass-through', Economic Modelling, vol. 26, no. 6, pp. 1270-1282.