Transmission of financial market interest rates to retail interest rates
The effectiveness of monetary policy transmission to the economy depends on how the interest rate conditions for credit financing of non-financial corporations and households are affected by financial market interest rates. The analysis of efficient transmission is also significant at present owing to certain signs of its potential weakening at a time of increased uncertainty in the financial markets. The analysis used interest rates on new loans and deposits of non-financial corporations and households for individual banks from January 2004 to December 2008. This made it possible to assess the direct link between financial market interest rates and client rates while taking into account the heterogeneity of banks. The median of retail interest rates was used.
Interest rates on new loans continue to show the strongest correlation with money market rates. The interest rate on loans to non-financial corporations with a rate fixation of up to one year is most closely linked with the 1M PRIBOR for small loans and the FRA rate for large loans. Interest rates on loans with a rate fixation of more than one year are most closely linked with the 1Y PRIBOR for small loans and the 3M PRIBOR for large loans. As regards housing loans, the correlation analysis indicated the strongest link with the gross yield on the 10Y government bond and with the 1M PRIBOR. The most important rates for deposits with an agreed maturity of up to two years and over two years are the 1M PRIBOR and the 3M PRIBOR respectively.
The character of the transmission was estimated using the error-correction model
where br is the client interest rate, mr is the financial market interest rate with the closest link to the given client interest rate, coefficient β1 represents the speed of return to equilibrium, β2 represents long-term transmission, μ is a constant in the equilibrium relationship and coefficient α2 indicates short-term transmission.
Table 1 (Box) Estimates of the pass-through of financial market interest rates to retail bank interest rates
(regression coefficients; standard errors in parentheses)
|Short-term pass-through α2||Long-term pass-through β2||Speed of adjustment β1|
|Interest rate on loans|
|Non-financial corporations (loans up to CZK 30 mil.)|
|Floating rate and initial rate fixation of up to one year||0.70(0.15)**||0.94(0.06)***||- 0.50(0.11)***|
|Initial rate fixation of over one year||0.52(0.44)||0.95(0.09)***||- 0.49(0.20)***|
|Non-financial corporations (loans over CZK 30 mil.)|
|Floating rate and initial rate fixation of up to one year||0.90(0.30)***||0.81(0.03)***||- 0.53(0.10)***|
|Initial rate fixation of over one year||0.90(2.20)||0.78(0.08)***||- 0.77(0.27)***|
|Lending for house purchase||- 0.13(0.23)||0.62(0.03)***||- 0.34(0.11)***|
|Interest rate on deposits|
|With agreed maturity of up to two years||0.70(0.09)***||0.93(0.02)***||- 0.61(0.09)***|
|With agreed maturity of over two years||0.68(0.63)||0.47(0.06)***||- 0.28(0.14)*|
Note: *** , ** and * denote significance at 1%, 5% and 10% level.
The transmission of money market interest rates to interest rates on loans to non-financial corporations was relatively strong in the period under review (see Table 1 Box). Complete long-term transmission for small loans to corporations and incomplete transmission for large loans to these clients was found. This may indicate lower competition and presence of relationship lending between banks and clients in case of large loans. In the case of short-term transmission, loans with floating rates and rates fixed for up to one year follow money market interest rates; 70% of the transmission for small loans and 90% for large loans takes place within one month. Rates fixed for periods longer than one year do not respond within one month. The adjustment of interest rates on corporate loans to changes in money market rates ranges between one month and two months. The transmission for interest rates on housing loans is incomplete. The existence of a mechanism of return to the long-term equilibrium is apparent. The transmission is more spread over time, and these rates on average do not react to changes in financial market rates within one month. Both short-term and long-term transmission is significant in the case of deposits with an agreed maturity of up to two years, but only long-term transmission is complete. Only long-term transmission is significant for deposits with an agreed maturity of over two years, but it is incomplete.
Table 2 (Box) Standard deviation of interest rates on loans of selected banks
|up to CZK 30 mil. with rate fixation of up to 1Y||1.79||2.08||2.24||2.17||2.28||2.28|
|up to CZK 30 mil. with rate fixation of over 1Y||2.52||2.49||2.54||2.46||2.59||2.58|
|over CZK 30 mil. with rate fixation of up to 1Y||1.26||1.10||1.28||1.10||1.03||1.70|
The results of an analysis carried on for a shorter period from 2006 to 2008, in which the observations since the deepening of the global financial crisis had a larger weight, were similar. However, the average standard deviation of interest rates on housing loans and corporate loans granted by selected banks started to rise in mid-2008 (see Table 2 Box). That seems to indicate that banks are differentiating between clients to a larger extent as a result of the deterioration in borrowers’ risks profiles and strengthened bank prudence.