Academic journal article International Advances in Economic Research

The Impact of Regulatory Measures on Commercial Bank Interest Rates: A Micro Analysis of the Barbados Case

Academic journal article International Advances in Economic Research

The Impact of Regulatory Measures on Commercial Bank Interest Rates: A Micro Analysis of the Barbados Case

Article excerpt

WENDELL MCCLEAN [*]

This study estimates the impact on commercial banks' interest-rate behavior of the more pervasive regulatory measures adopted by the Central Bank of Barbados. The results indicate that the cash ratio, the stipulated government securities ratio, and the savings deposit rate floor significantly impacted the loan rate for every bank. Generally, the deposit rate for any given bank has been responsive to fewer policy variables than the loan rate. The loan rates, though generally responsive to all policy variables other than the bank rate, have exhibited very low elasticities. The results indicated that the ceiling on the average lending rate, when it existed, depressed loan rates by less than 1 percent on average. This is largely attributable to the Central Bank's policy of adjusting the ceiling in line with market trends. (JEL E40)

Introduction

Since the establishment of the Central Bank of Barbados in 1972, commercial banks have been subjected to a wide variety of regulatory controls. [1] From August 1978 to the present, the Central Bank has prescribed the minimum interest rate payable by commercial banks on savings deposits. This interest rate floor has been applied to every class of deposit from March 15, 1994. Ceilings were imposed on deposits, in accordance with maturity and size of deposit, from October 1973 to October 1982. A ceiling was also imposed on the average loan rate from May 1976 to August 1991. There was a floor on the prime lending rate from May 1976 to June 1984.

Several restrictions have also been imposed on the composition of the assets portfolio of commercial banks. In addition to a minimum cash reserve ratio, commercial banks are required to hold a stipulated minimum amount of government securities, expressed as a proportion of deposits. Sectoral restrictions and other specific restrictions targeting the personal and distributive sectors have frequently been imposed. Commercial banks have also been subjected to foreign exchange restrictions, including Central Bank directives regarding the holding of foreign assets.

The impact and efficacy of these regulatory measures have been investigated in Williams [1996] and Worrell [1997]. The former focused on bank performance, as measured by profitability and market share, vis-a-vis other financial institutions. The latter addressed the impact of regulation on commercial bank interest rate and portfolio decisions. However, these studies were based entirely on hypothetico-deductive reasoning rather than econometric analysis. This study estimates the impact on commercial banks' interest-rate behavior of the more pervasive regulatory measures adopted by the Central Bank of Barbados.

This paper is organized as follows. The second section outlines various regulatory measures used since the inception of the Central Bank. The third section will discuss the theoretical perspective that has informed the study and presents a model of the banking firm. The fourth section describes the data set and presents the results of unit root tests and pair-wise Granger causality analysis. The fifth section reports the results obtained from a system of reduced-form equations that accord with our theoretical model. The study concludes in the sixth section with some evaluative comments on the efficacy of Central Bank regulation of commercial banking activity in Barbados.

Regulation of the Banking System

The complexities that risk and uncertainty impose on commercial bank assets and liabilities management have been compounded by Central Bank regulation. Since its inception in 1972, the Central Bank has imposed various restrictions on commercial banks as part of the government's stabilization program. These regulatory measures include cash reserves, security requirements, credit controls, and interest rate ceilings and floors.

A legal cash reserve requirement for commercial banks was introduced by the Central Bank in 1973 at 2 percent of the commercial bank deposit liabilities. …

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