Interest rate setting by universal banks and the monetary policy transmission mechanism in the euro area pot

Interest rate setting by universal banks and the transmission mechanism in the euro area 1 Interest rate setting by universal banks and the monetary policy transmission mechanism in the euro area Gabe de Bondt, Benoît Mojon and Natacha Valla* 6 November 2002 Preliminary Draft Abstract This paper empirically analyses the pass-through of changes in market interest rates to retail bank interest rates in euro area countries. The results confirm earlier findings that retail bank rates adjust sluggishly to market rates. Differences in the degree of this pass-through persisted after the introduction of the euro, both across the five segments of the retail bank markets analysed and across the ten euro area countries considered. First, the sluggishness is not generally due to an ability of “universal” banks to fund loans by deposits rather than securities. Second, estimation results of linear and state dependent error correction models show that retail bank interest rates adjust to changes in funding (lending rates) or opportunity costs (deposit rates), which are approximated by a weighted average of short and long-term market interest rates. Furthermore, it is found that the introduction of the euro has speed up the adjustment of retail bank interest rates to market interest rates. One possible factor behind this evolution is in the evolution could be related to competitive forces in the different segments of the retail bank market. Keywords: retail bank interest rates; market interest rates; euro area countries JEL classification: E43; G21 European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, GERMANY. E-mail addresses: gabe.de_bondt@ecb.int, benoit.mojon@ecb.int, and natacha.valla@ecb.int. We thank Jesper Berg, Francesco Drudi, Michael Ehrmann and Oreste Tristani for their reflexions on a previous draft, Hans-Joachim Klockers for his comments and Rasmus Pilegaard for excellent data assistance. All views expressed are those of the authors alone and do not necessarily reflect those of the ECB or the Eurosystem. Interest rate setting by universal banks and the transmission mechanism in the euro area 2 1. Introduction The level of interest rates is one of the main determinants of savings and investment decisions. When making these decisions, euro area households and firms are mainly confronted with retail bank interest rates. In 2000, the amounts outstanding of loans to non-financial corporations of the euro area were seven times as large as debt securities. Moreover, traditionally deposits are larger than money mutual funds (Agresti and Claessens, 2002; ECB’s Report on Financial Structures, 2002). It is also clear that the response of bank retail rates to changes in the interest rates on the refinancing operations controlled by the central bank is a major link in the transmission of the ECB monetary policy. A growing literature has shown the sluggishness of retail banks interest rates in the euro area. As shown in Table 1 (reproduced from De Bondt 2002), the complete pass-through from changes in the money market rates to retail bank rates takes at least several months 1 . These results are usually based on reduced form regressions of retail bank rates on the money market rate. While this modelling approach provides a good summary evaluation of this sluggishness, it falls short of explaining its determinants. To remedy this gap, this paper estimates semi-structural equations of interest rate setting by euro area banks, which we see as being in their majority “universal”. 2 Our study covers five categories of euro area retail bank rates, four loans (short-term and long-term loans to firms, mortgages and consumer credit), and one time deposits interest rates. We use time series of retail rates and market rates from ten of the twelve euro area countries as well as for the euro-area aggregate. “Universal” banks, which we define by opposition to “specialised” banks, should in principle enjoy economies of scope. In particular, the rates on loans granted by universal institutions may depend on the cost of raising deposits rather than issuing securities. Such a deposit-based funding of loan activities could imply that retail bank rates remain little responsive to market conditions once deposit rates are accounted for. On the contrary, specialised banks without branches collecting deposits would set their retail loan rates on the basis of their market-based funding. Within our framework, this ability of continental European banks to avoid market funding using deposits instead is one possible explanation for the retail rates sluggishness. 1 This is in sharp contrast with the U.S., where, as shown in Sellon (2001), the spread between the prime lending rate and the federal funds rate has been constant, implying a complete instantaneous pass-through, for nearly a decade. 2 Indeed, banks in the euro area benefit from a very broad range of authorised operations. This became formally true with the second European Banking Directive (1989), which formalised a tendency that had already emerged earlier on in key euro area countries. The functional separation of banking activities indeed gradually disappeared since the mid-1970s: 1974 in Spain, 1975 in Belgium, 1989 for the Netherlands, 1984 in France, 1990 in Italy. Moreover, in Germany and Austria, universal banking had been the grounding principle of banking activities ever since the beginning of the 20th century. Overall, there is a long tradition of universal banking across euro area countries. We note that universal banking may refer not only to household lending, deposit-taking and investment financing, but also brokerage, equity holding, portfolio management and trading. Moreover, the multiplication of mergers and acquisitions has led to the creation of conglomerates involving banks, insurance and securities companies that have strengthened the universal character of European banks (see Cybo-Ottone and Murgia (2000)). However, given the scope of our paper, we shall stick to a “narrow” definition of universal banking and refer to the set of “traditional” retail banking activities. Interest rate setting by universal banks and the transmission mechanism in the euro area 3 Another explanation for the sluggishness of retail bank rates is that funding costs are not entirely indexed to the money market rate. First, banks may try to limit interest rate risk on long-term loans by increasing the maturity of the funding of such loans. Second, in the presence of adjustment/menu costs, uncertainty about the persistence of changes in money market rates may induce banks to define a target retail rate as a function of long-term rates, as a smooth indicator of future changes in money market rates. Our initial tests reject the idea that retail bank rates on deposits have, conditionally on the level of market interest rates, a significant influence on retail bank rates on loans. We then show that the dynamics of each retail bank interest rate can be specified separately within an error correction model (ECM). In the long run, banks set their retail prices in line with their marginal costs, i.e. the funding costs of loans and the opportunity costs of deposits. Both the funding and opportunity costs are modeled as a weighted average of the three-month money market rate (MMR) and the 10-year government bond yield (BR). This way, the marginal cost of retail bank instruments are more accurately captured than in previous studies, which typically examined only the short-term market interest rate. Nevertheless, it can not be ruled-out that our empirical findings are distorted by maturity mismatches or yield curve effects, since it is unclear whether our freely estimated weighted average of the short and long-term interest rates have a comparable maturity with the underlying retail bank instrument. 3 In the short run, changes in retail bank rates depend on changes in the MMR and in the BR and on the deviation from the long-run equilibrium relationship between the retail bank interest rate and short- and long-term interest rates. The stability of the baseline linear ECM before and after the introduction of the euro is then tested and we assess whether more general state dependent models are preferable to the linear specification. A break in January 1999 is found in the estimated linear ECM in about half of the cases. One possible explanation for this break may be associated to the evolution of the competitive forces in the different segments of the retail bank market since the introduction of the euro. For instance, the time deposit and mortgage markets have seen some new entrants, in particular internet banks. In addition, for non- financial corporations, non-bank sources of finance, in particular debt securities, have increased in recent years (De Bondt, 2002c). This paper has three key contributions. First, it shows that the sluggishness in the response of retail rates to market rates is not due to the possibility of banks to fund their loans through the issuance of deposits. Second, it shows that retail bank interest rates in euro area countries adjust to changes in marginal funding or opportunity costs, approximated by a weighted average of short and long-term 3 At the euro area level De Bondt (2002a) examines the adjustment of retail bank interest rates to market interest rates with a comparable maturity. Interest rate setting by universal banks and the transmission mechanism in the euro area 4 interest rates. The weight of market rates in the equilibrium target of retail bank rates, which has been largely ignored in the literature on the pass-through, is found to be an important factor behind the sluggishness of the response of bank rates to market rates. Third, we find that in a large number of national retail markets, the introduction of the euro has affected bank pricing. The paper is structured as follows. Section 2 presents available evidence on interest rates pass-through process in individual euro area countries. The theoretical model of bank pricing is presented in section 3. Section 4 provides an overview of the data. Section 5 discusses the empirical results and Section 6 concludes. 2. The pass-through to retail bank interest rates: literature review(s) While recent studies on the retail bank interest rate pass-through stress the sluggishness in the adjustment of retail bank rates, they usually do not provide explanations for it. Against this background, we discuss how the complementarities across bank’s activities can explain the lack of responsiveness of bank rates to market conditions. 2.1. An incomplete interest rate pass through in individual euro area countries Table 1 summarises the main findings of interest rate pass-through studies performed for individual euro area countries. All studies show cross-country differences in the interest rate pass-through, although no clear pattern in those differences seems to emerge . Studies from the mid-1990s broadly show that changes in official and/or money market rates are not fully reflected in short-term bank lending rates to enterprises after three months, but that the pass- through is higher in the long term (BIS, 1994, Cottarelli and Kourelis, 1994, and Borio and Fritz 1995). Recent cross-country studies by Kleimeier and Sander (2000 and 2002), Donnay and Degryse (2001), Toolsema et al. (2001), and Heinemann and Schüller (2002) confirm this finding. Hofmann (2000) and Mojon (2000) also find short-term sluggishness in short-term bank lending rates to enterprises, but assume a priori a complete long-term pass-through. As regards long-term bank lending rates to enterprises and households, all studies, except BIS (1994), typically show that the pass-through tends to be less complete than for short-term bank lending rates to enterprises. This finding may be driven by the fact that the funding costs are approximated by money market interest rates, which may not always be the most appropriate marginal funding costs, in particular for long-term loans to enterprises and mortgages. Furthermore, changes in and convergence of financial structures among euro area countries is a potential determinant of the interest rate pass-through. For instance, Mojon (2000) concludes that Interest rate setting by universal banks and the transmission mechanism in the euro area 5 deregulation has significantly affected the interest rate pass-through process for deposits, but not for loans. 2.2. Bank studies on the interest rate pass-through The industrial organisation literature typically examines the link between bank interest rate margins and the market structure of the banking system using bank data. (Hannan and Berger, 1991, Neumark and Sharpe, 1992, Angbazo, 1997, Hannan, 1997, Wong, 1997, and Corvoisier and Gropp, 2001). The main lesson of these banking structure studies is that the pricing behaviour of banks may depend on the degree of competition and contestability in the different segments of the retail bank market. For instance, Corvoisier and Gropp (2001) conclude that for demand deposits and loans increasing bank concentration in individual euro area countries during the years 1993–1999 may have resulted in less competitive pricing by banks, whereas for savings and time deposits the opposite seem to be the case. 2.3 Loans pricing by universal banks The vast empirical literature that has tested the existence of economies of scope is largely inconclusive. However, the complementarities across bank activities can explain the sluggishness of retail bank rates. One factor of retail bank rate sluggishness that has not received much attention is the ability of banks to exploit the complementarity of their activity. In a universal banking environment, the way banks set retail interest rates pertains to the general - and overall inconclusive - debate on complementarities and scope in banking. A widespread belief suggests that banks tend to expand the scope (and possibly scale) of their activities because of the allegedly increased competition in traditional banking activities 4 . Unfortunately, the economic benefits from expanding scope seem are not overwhelmingly echoed in the data (Berger et al 1993). The enormous literature estimating costs and production functions of banks remains relatively inconclusive on the issue (see the survey in Clark (1988) and Altunbas (2001) and Bikker (2001)). Regressing three different measures of bank profits on bank- 4 Because they need to improve their cost efficiencies to operate more effectively, scale expansion would be justified. In parallel, by squeezing margins, tougher competition would force banks to seek profits outside familiar territories. This argument, however, is not strongly supported empirically. In addition, cost efficiency arguments suppose a focus on “core” competencies. They are therefore difficult to reconcile with scope expansion (Hamel and Prahalad (1990)). A more appealing argument relates to the strategic benefits that may arise from increasing scope (and size). Milbourn, Boot and Thakor (1999) suggest that banks may enlarge the scope of their activities because it enhances the reputation of their management and/or increases the wealth of shareholders. In addition, strategic benefits may also arise if (i) current operations are sufficiently profitable to finance the fixed costs associated with scope expansion, (ii) uncertainty about the core competencies required to successfully run new operations is sufficiently high, and (iii) expected competition in the prospective market is low enough so as to make the effort worthwile. By stressing the role of informational uncertainty and learning for a wider scope to be optimal, this argument suggests that unless very specific conditions are met, it does not pay, on average, to be diversified. See also Berger. and Humphrey (2000) and, for European studies, Altunbas (2001) and Bikker (2001). Interest rate setting by universal banks and the transmission mechanism in the euro area 6 specific and country specific variables, Steinherr (1994) singles out the significantly larger influence of costs, competition and regulation on the profits of universal banks relative to those of specialised institutions. However, those results do not say much on the disaggregation of those three factors by activity. Overall, estimating complementarities and economies of scope is subject to a range of practical problems. Among the issues identified in Berger, Hunter and Timme (1993), two are of direct interest to us. First, data on specialized banks are scarce. This issue is particularly fierce when using a narrow definition of universal banking as we do here. In particular, banks in the euro area tend to produce the entire array of retail banking outputs. 5 Second, the data used to evaluate economies of scale correspond to a point which is far from the efficiency frontier. In that sense, scope economies may be mistaken for X-efficiencies. 6 However, for our purpose, the prevalence of universal banks in the euro area may affect the transmission of market interest rates to retail banking conditions even if economies of scope are not large. In particular, the multi-business nature of universal banks may help them to manage interest rate risk and dampen the effect of fluctuations in market conditions. To that respect, specialized institutions may either add a portfolio of liquid securities and/or recourse to money market instruments and central bank liquidity. Universal banks have another option. As they handle both loans and deposits, they may in principle shelter lending activities from market conditions not only by spreading risk across loan markets segments, but also by “using deposits” as an input to producing loans. By doing so, banks should buffer the impact of market conditions on retail loans rates, and create a causal link from deposit rates to lending rates. The question as to whether deposits are inputs or outputs for universal banks has been raised in the intermediation literature. On the one hand, they have been considered as inputs for the production of loans, i.e. as a source of liquidity, which is then redistributed under various maturities to agents in need of financing. Alternatively, we may argue that deposits are also an output, as retail banks are service producers to depositors. Without clinching the matter, Sealey and Lindley (1977) view deposits as an intermediate input which is produced by banks (they offer means of payments and a remuneration to depositors), and then used in the production of loans. Hughes and Mester (1993a, b) estimate a variable cost function with a fixed level of deposits. Their estimate of this function’s derivative with respect to deposits being negative, they conclude that deposits are inputs. The “user cost methodology” proposed by Hancock (1991) is also insightful. Hancock regresses bank profits on 5 They all tend to be away from the zero-output, which creates extrapolation problems. 6 The relevant literature suggests that there has been a systematic bias in earlier measures of scope and scale economies for banking activities, because this distance from the efficiency frontier, and to some extent the risk attitude of banks’ managers, were both overlooked (Hughes and Mester (1993a, b)). The cost and revenue efficiency of evolving financial institutions has also been empirically investigated ,see e.g. , Berger, Hunter and Timme (1993). Interest rate setting by universal banks and the transmission mechanism in the euro area 7 the real balances of all items of its balance sheet without earmarking loans and deposits as being ex ante outputs or inputs. The input/output distinction emerges endogenously from the sign of the regression coefficients. Positive estimates correspond to outputs, while negative estimates correspond to inputs. She finds that loans and deposits are outputs, while cash (time deposits and borrowed money) is an input. As a result, retail interest rates in loans markets may depend on retail pricing for deposits, a phenomenon less likely to emerge when banks are specialised. Hence it appears that the dominance of universal banking in the euro area could be a factor for the sluggishness of retail bank rates. 3. A model of bank pricing From a static point of view, the links between market and retail interest rates has an immediate interpretation in terms of bank profit maximizing and pricing. An equilibrium relationship between retail and market rates may be obtained in a simple static Monti-Klein bank where banks hold money market instruments and longer term assets. 7 A “universal” bank with some monopoly power chooses the volumes of loans L and deposits D that maximise its profits given by [1] ),( LDCDrBrMrLr d b s l −−++=π C(.) is a well behaved cost function. M is the bank’s net position on the interbank market and B its net longer term assets holdings (“bonds”) which, given mandatory reserve requirements a, satisfy the balance sheet condition: [2] (1- a)D – L = M+B s r and b r are the interest rates prevailing in the money and bonds markets. They are taken as given by the bank. Money market instruments and bonds are held with proportions k and (1-k), that is [3] M = k [(1- a) D + L] [4] B=(1-k)[(1- a) D + L] Rewriting profits accordingly, the first order conditions for the supply of loans and the demand for deposits yield a pricing rule for each market i (i = deposits, various loans), for given inverse demand and supply functions )(Lr l and )(Dr d : 7 More elaborate profit-maximizing oligopoly models have exploited large detailed datasets, see Steinherr and Huveneers (1994). Interest rate setting by universal banks and the transmission mechanism in the euro area 8 1 ] 1 1][')1([]5[ − −+−+= i ibsi Crkkrr ε where i ε represents the price elasticity of the demand for loans (i =loans) and the supply of deposits (i=deposits). Under perfect competition with complete information, ∞→ i ε , price equals marginal cost and its derivative with respect to marginal costs equals one. This derivative typically falls below one when the demand for loans (supply of deposits) is not fully elastic with respect to the bank lending (deposit) rate, or if banks have some degree of market power (Laudadio, 1987). A wide range of factors influences market power. Entry into the banking sector may be restricted by regulatory agencies, thereby creating room for monopoly power and administrated pricing (Niggle, 1987). Market power and an inelastic demand for retail bank products may also result from the existence of switching costs (Klemperer, 1987, and Sharpe, 1997) or asymmetric information costs. The former is expected to be particularly relevant for bank deposit rates and the later for bank lending rates. Moreover, beyond the static framework of the model, bank rates may fluctuate around the target rate presented in Equation [5] because of adjustment costs. Overall, the resulting pricing equation [5] highlights the key role played by long term rates when the longer term assets held by banks are taken into account when they maximise profits. [5] states that retail rates are set as a weighted average of market interest rates, corrected for market structure and banking costs. The interdependence between the deposit and lending activities in which a universal bank is involved appears via the cost structure of banking activities. If the markets for deposits or loans are segmented, the properties of the cost function determine whether developments in one market have an impact on retail rates in other markets. In particular, the cost function is defined on both deposits and loans and should not be separable in those arguments for a bank engaging simultaneously in various lending and deposit markets. In particular, the equilibrium volume of deposits chosen by the bank will depend on the rate prevailing in that market, so that the marginal cost of loans in [5] can be explicitly written as )),((' LrDC dl and is in general not a linear function of d r . 8 While in [5] the relationship between lending rates and market rates is linear, the impact of d r on l r is going to be linear only in the specific case where ' d C is itself a linear function of d r , i.e. if BArC dd +=' where A and B may be functions of quantities and cost parameters. As a consequence, we concentrate on a linear specification including both market rates but leaving deposit rates out of the information set. 9 This is coherent with the fact 8 It would be linear for example with a quadratic cost function and a linear demand for deposits. 9 This step is warranted by the results of Granger causality tests presented below, suggesting that A=0. Interest rate setting by universal banks and the transmission mechanism in the euro area 9 that a baseline Monti-Klein bank considers retail interest rates to be independent from each other across markets. 4. Data National retail bank markets provide independent observations to investigate bank pricing. Indeed, these markets remain segmented in spite of the institutional changes and the market consolidation that financial intermediaries went through in the last two decades. In contrast to the increasing integration of securities markets and wholesale finance services across countries (Pagano et al. 2002), the consolidation of the banking sector took mostly place within national borders. This national segmentation explains, among other factors, why the pass-through of changes in market interest rates to retail bank interest rates is different across euro area countries (see Table 1) 10 . The analysis is carried out on 46 retail interest rate series for all euro area member states except Luxembourg and Greece, the euro area and the associated MMR and BR. All series have a monthly frequency - except for France, where the model is estimated on quarterly data - and are available from the ECB national retail interest rate database. 11 They correspond to five main financial instruments that reflect different segments of the banking sector. They include interest rates on short (10 series) and long-term (6 series) loans to firms, mortgages to households (10 series), consumer credit (7 series) and time deposits (9 series). One should note that from January 1999, the MMR is the EURIBOR for all countries. Each of those five categories may differ across countries by their main characteristics, namely habitat, maturity, the average size of each transaction, and risk. The rates on short-term loans are reported, when specified, for maturities ranging from up to three months (Spain) to up to 18 months (Italy). Long-term loans to enterprises refer to investment credit of over one year. Consumer loans include overdrafts (e.g. Ireland), but usually correspond to a weighted-average of short-term credit lines, personal loans, and longer-term installment credit. Housing and mortgage loans typically have a longer maturity, specified over 18 months (Italy) to three (Spain) to five years (Germany, Portugal). Finally, we restrict our analysis of deposits to the interest rate on time deposits, which are the only deposit rates that are available for a large enough number of countries. We estimate the models on sample periods that excludes the turbulent years of the early 1990s, when interest rates have been quite volatile, as they had to respond to a number of shocks, notably exchange 10 It is worth stressing that, while the levels of retail bank rates, and their spread with respect to market rates are not directly comparable, the pass-through from market rates to retail bank rates is more comparable. 11 The series we use and a detailed description of their characteristics is available at www.ecb.int. Interest rate setting by universal banks and the transmission mechanism in the euro area 10 rate crises. This clearly appears in Charts 1 and 2. For most countries, the ERM crises of the early nineties led either to out-liers (Ireland, Belgium, France, Italy) or to periods of high volatility of market rates (Spain, Portugal, Finland). We trust that such turbulence can never take place in EMU. Hence, for these countries, the sample period of estimation starts in 1994:4. For Germany and the Netherlands the estimation sample starts in 1991:1. In Austria, which also was part of the core ERM, the estimation starts in 1995:7 because retail bank rates are not available before. 12 Nevertheless, it can not be excluded that our results are distorted by a change in yield curve effects. Two final observations on the data are worth noting. First, Charts 1 to 4 indicate a clear downward trend in all the market and retail bank interest rates in the period prior to EMU. In addition to the upturn, which took place after April 1999, the other main episode of rising interest rates corresponds to the winter 1994 crash on bond markets which was triggered by the February 1994 increase in the Fed funds rate. Second, the well-known hierarchy in the mark-ups across retail bank markets, i.e. largest on consumer credit, lowest on mortgages with loans to firms in between, is widely observed across countries. 5. Empirical estimations 5.1 Do lending rates depend on market rates? The first step in our empirical analysis is to check whether banks insulate lending rates from market conditions thanks to the funds collected as deposits. We look at this issue by investigating the extent to which deposit rates have a predictive power with respect to lending rates. For that purpose, we implement Fisher tests on the coefficients of market rates and deposit rates in equations of lending rates such as: ∑ ∑∑∑∑ = = − = −− = − = − +++++= n i t n i iti n i itiiti n i iti n i itit brmmrddxx 1 1 1 1 1 22212211 εγγββα where x, mmr, br, d1, d2 are retail loan rate, the short-term and long-term market rates, interest rates on deposits (time deposits, savings accounts or current accounts depending on the country), while i l is alternatively the interest rate on loans to firms (short and long), consumption credit and mortgages. We test which interest rate Granger causes each of our four lending rates. Results shown in Table 2 reveal that deposit rates are not relevant for interest rates on loans in a clear majority of cases (25 out of 32 across the four types of loans). The 7 observations where the lags of at least one deposit rate are relevant are concentrated in Austria (all markets but mortgages) and to some extent in Belgium. In terms of markets, cases are concentrated in loans to firms, both short and long. 12 In the case of France where our data is quarterly, however, the full sample is extended to 1991:1 – 2001:4 (1998:1 onwards for the EMU-sample). [...]... concentration and retail interest rates, ECB Working Paper, 72 Cottarelli, C and A Kourelis, 1994, Financial structure, bank lending rates, and the transmission mechanism of monetary policy, IMF Staff Papers, 41, 4, 587-623 Cybo-Ottone, A and M Murgia, 2000, Mergers and Shareholder Wealth in in European Banking, Journal of Banking and Finance 24, pp 831-859 19 Interest rate setting by universal banks and the transmission. .. rates and credit rationing: an application of unit root testing and error correction modelling, Applied Economics, 31, 267-277 Wong, K.P., 1997, On the determinants of bank interest margins under credit and interest rate risks, Journal of Banking and Finance, 21, 2, 251-271 21 Interest rate setting by universal banks and the transmission mechanism in the euro area Appendix on state dependent pricing... attributed to the universal nature of banking sectors in continental Europe, but rather to a longer term view of their “equilibrium” funding and opportunity costs related to their balance sheets 18 Interest rate setting by universal banks and the transmission mechanism in the euro area References (to be completed) Agresti and Claessens, 2002, mimeo ECB Altunbas, Y., 2001, Efficiency in European banking, European... direct interpretation as meaningful economic relations, and identifying restrictions have to be imposed To our view, imposing such restrictions would be too strong 12 Interest rate setting by universal banks and the transmission mechanism in the euro area Equation [6] relates the changes in the retail rate to its own lags, the changes in the long and the shortterm market rates and the error-correction term... patterns The immediate, i.e within one-month pass-through, from short and long-term market interest rate changes to retail bank interest rates differs across retail bank products, as shown by Charts 8 On the 14 Interest rate setting by universal banks and the transmission mechanism in the euro area corporate side, banks adjust their short-term loan rates more sluggishly than longer-term loans rates (on.. .Interest rate setting by universal banks and the transmission mechanism in the euro area By contrast to this very occasional relevance of deposit rates, the coefficients for short and/ or long term market rates contain quasi systematically valid information for lending rates On the basis of those properties, we vastly reject the buffer role of deposits for the pricing of loans and consider that banks. .. sheet 11 Interest rate setting by universal banks and the transmission mechanism in the euro area This mark-up is related to the multiplicative term [1 − 1 −1 ] in equation (5) Given the various εi maturities of the supplied financial instruments, those conditions are reflected by both short and longterm market interest rates In addition to be intuitive, the specification is appropriate to discriminate... Interest rate setting by universal banks and the transmission mechanism in the euro area markets in Spain, Finland and Portugal For time deposit rates, the error-correction coefficients are found to vary between 20% and 50%, with the exception of Austria and the Netherlands where the adjustment to equilibrium is slower Did EMU have an impact on the pass-through? (i) Assessing stability To assess the stability... within the US Similar type of results for European national retail bank markets were discussed in section 2 The effects of structural features of European national retail bank markets on bank’s pricing will be further investigated in a follow up to this paper 13 Interest rate setting by universal banks and the transmission mechanism in the euro area 1999 The equation is then fit separately for the. .. downs turns 22 Interest rate setting by universal banks and the transmission mechanism in the euro area asymmetry in the error correction mechanism2 2 ρ takes one of two values depending on whether the deviation from equilibrium term is positive or negative – that is, depending on whether the retail interest rate is above or below its long-run equilibrium value for given market rates The estimated relation . Interest rate setting by universal banks and the transmission mechanism in the euro area 1 Interest rate setting by universal banks and the monetary policy. credit Interest rate setting by universal banks and the transmission mechanism in the euro area 16 markets in Spain, Finland and Portugal. For time deposit rates,