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The impact of bank competition on the interest rate pass-through in the euro area

The impact of bank competition on the interest rate pass-through in the euro area. Michiel van Leuvensteijn (Centraal Planbureau) Christoffer Kok-S ø rensen (European Central Bank) Jaap Bikker (De Nederlandsche Bank) Adrian van Rixtel (Banco de España).

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The impact of bank competition on the interest rate pass-through in the euro area

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  1. The impact of bank competition on the interest rate pass-through in the euro area Michiel van Leuvensteijn (Centraal Planbureau) Christoffer Kok-Sørensen (European Central Bank) Jaap Bikker (De Nederlandsche Bank) Adrian van Rixtel (Banco de España) 11th Conference ECB-CFS Research Network, Prague, 20 October 2008. The views expressed are those of the authors and do not necessarily represent those of the CPB, ECB, DNB and BdE.

  2. Structure • What did we analyse? • How did we analyse this? • What are the results?

  3. 1. What did we analyse? • Importance of competition to pass-through: • Bank competition is likely to have an impact on both the level and the changes of bank interest rates. • The bank interest rate channel is a key element of the monetary policy transmission mechanism in the euro area.

  4. 1. What did we analyse? • What is the impact of competition on the bank interest rate pass-through? • Three questions: • Are bank loan rates lower (and deposit rates higher) in more competitive markets? • Do bank interest rates adjust stronger to changes in market rates in more competitive markets … 2a. In the long-run? 2b. In the short-run (immediate adjustment)?

  5. 1. What did we analyse? • Our contribution: • We use a new indicator to measure bank competition: The Boone indicator. • We look at both levels and changes using a (ECM) panel framework. • We look at specific product segments of the loan and deposit markets.

  6. 2. How did we analyse this? • Two major steps of analysis: • Step 1: Estimation of our measure of bank competition: The Boone indicator. • => Previous paper: “A new approach to measuring competition in the loan markets of the euro area” (NBER, Tokyo, June 2007). • Step 2: Estimation of the relationship between the Boone indicator and bank interest rates.

  7. 2a. How: The Boone indicator New approach to measure competition: Boone indicator (Jan Boone, Tilburg University; Economic Journal, 2008). • Central notion of the Boone indicator: • Competition rewards efficiency and punishes inefficiency => linkage between relative marginal costs (MC) and relative market share. • In competitive markets, efficient banks have larger market shares than inefficient banks.

  8. 2a. How: Boone indicator • Model: To obtain the Boone indicator, we need to estimate the relationship between relative market shares and relative marginal costs (MC) for each country. Thus: • ln (market shareit) = αt + βtln (MCit)+ vt • βtis the Boone indicator. • βt should be negative: Market shares increase for banks having lower marginal costs relative to their competitors. The larger (in absolute terms) the value of βt, the stronger should be competition.

  9. 2a. How: Boone indicator • Model: • Step 1: We estimate translog cost functions for all countries. • Step 2: We estimate the marginal costs (in relative terms) for all banks on the basis of these translog cost functions. • Step 3: We estimate the relationship between market share and marginal costs, which gives us the Boone indicator.

  10. 2a. How: Boone indicator • Data: • Extended Bankscope, individual bank data. • Period: 1992 – 2004. • 8 euro area countries: Austria, Belgium, France, Germany, Italy, the Netherlands, Spain and Portugal. • Total number of banks: Around 2,800.

  11. Results Boone indicator

  12. 2b. How: Boone indicator and bank interest rates. • Data: • MIR and NRIR interest rate statistics, and corresponding market interest rates. • Period: 1994-2004; monthly data. • 8 countries: AT, BE, ES, DE, FR, IT, NL, PT. • 6 types of bank products: • 4 bank loan rates: Mortgages, consumer loans, short-term and long-term loans to enterprises. • 2 bank deposit rates: Current account and time deposits.

  13. 2b. How: Boone indicator and bank interest rates. • If there is a long-run co-movement of bank and market rates (long-run pass-through) ... • then its is appropriate to model the pass-through process using an Error-Correction Model (ECM). • Test results: • All bank and market interest rates are non-stationary, according to both Im-Pesaran-Shin (2003) and Hadri (2000) tests. • Bank and market interest rates are co-integrated according to the Pedroni (1999, 2004) test.

  14. 2b. How: Boone indicator and bank interest rates. • Question 1: Loan rates lower if more competition? • Simple spread model (Section 6.2 paper): • BRi,t - MRi,t = α BIi,t + δi Di + δt Dt + µi,t • BR = Bank interest rate (both lending and deposit rates) • MR = Market interest rate • BI = Boone indicator • Di = Country dummies (suffix i for individual countries) • Dt = Monthly time dummies • Ho: Parameter of Boone indicator α < 0. • ECM (… but results not significant).

  15. 2b. How: Boone indicator and bank interest rates. • Q2a: LR pass-thr. stronger with more competition? • ECM: BRi,t = α BIi,t + βi MRi,t + γ BIi,t MRi,t + δi Di + µi,t • γ = parameter of cross term of Boone indicator times market interest rate (BIi,t MRi,t) • Ho: Parameter of cross term γ > 0. • Q2b: SR pass-thr. stronger with more competition? • ECM: ΔBRi,t = θiµi,t-1+ ηiΔMRi,t+ φBIi,tΔMRi,t + δiDi + µi,t • θiµi,t-1 = residual LR relationship, 1 month lagged. • Ho: Parameter of cross term φ > 0. • Results not significant.

  16. 3. Results: Spread model Competition effect on bank interest spread: Correct and significant negative sign Parameter Boone indicator α Rates on mortgage loans -0.030 *** Rates on consumer loans -0.075 *** Short-term rates on corporate loans -0.128 *** Long-term rates on corporate loans 0.003 Current account deposit rates -0.154 *** Time deposit rates -0.036 *** *** = 99% confidence

  17. 3. Results: Long-run ECM Competition effect on long-run pass through: Correct and significant positive sign Parameter cross term (Boone indicator times market interest rate) γ Rates on mortgage loans 0.053 *** Rates on consumer loans 0.057 *** Short-term rates on corporate loans 0.039 *** Long-term rates on corporate loans 0.046 *** Current account deposit rates 0.037 *** Time deposit rates -0.015 *** = 99% confidence

  18. 3. Results: The effects of competition on spreads Parameter of the Boone indicator α (from the spread model) times the average of the Boone indicator for 1994-2004.

  19. Conclusions • Spreads between bank interest rates and market interest rates are lower in more competitive markets than in less competitive markets. • Competition has a positive influence on the long-run bank interest rate pass-through. • Competitionhardly increases the immediate or short-run response of loan rates to changes in market rates (although weaker evidence). • Changes in the competitive landscape may have important implications for monetary policy transmission in the euro area.

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