The Impact of Monetary Policy on Lending and Deposit Rates in Pakistan: Panel Data Analysis

By Mohsin, Hasan Muhammad | The Lahore Journal of Economics, September 2011 | Go to article overview

The Impact of Monetary Policy on Lending and Deposit Rates in Pakistan: Panel Data Analysis


Mohsin, Hasan Muhammad, The Lahore Journal of Economics


Abstract

This study estimates the impact of monetary policy on lending and deposit rates in Pakistan, using bank data for the period November 2001 to March 2011. We find evidence of a long-run relationship between the lending and discount rate, but the deposit rate is not co-integrated, and the pass-through is not complete. The study finds that, overall, banks pass on only 20 percent of the impact of a change in the discount rate to lenders in the first month. There is also a significant difference among various banks' pass-through rates. A short-run analysis reveals that the pass-through of the deposit rate is low at 0.16, which implies that the effectiveness of monetary policy is limited in Pakistan.

Keywords: Monetary Policy, Lending, Deposit Rates, Pakistan.

JEL Classification: E43, E52.

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The interest rate is one of the tools of monetary policy. Passthrough refers to the transmission of the benchmark interest rate-the discount rate in this case-to the lending and deposit rates in the economy. The pass-through is completed when any change in the discount rate is immediately transmitted to the lending and deposit rates (Bernanke & Blinder, 1992; C. Romer & Romer, 1989). The completeness implies that monetary policy is very effective and that the central bank can influence output and consumption without much delay.

Many studies have estimated the degree of pass-through for developed countries, e.g., in Europe, the US, and the UK (see de Bondt, 2002; De Graeve, De Jonghe, & Vander Vennet, 2004; Kleimeier & Sander, 2006; Liu, Margaritis, & Tourani-Rad, 2008; Mojon, 2000; Sørensen & Werner, 2006). However, there is no consensus on the completeness of pass-through. Some studies report completeness in the pass-through process with respect to benchmark monetary policy instruments (see Altunbas, Fazylov, & Molyneux, 2002; Bernanke & Gertler, 1995; Cook, 2008; Kashyap & Stein, 2000). Others contradict these findings and provide empirical evidence in favor of the incompleteness of pass-through. They also find heterogeneity across countries, financial institutions, and retail bank products (see de Bondt, 2002; Hofmann & Mizen, 2004; Liu et al., 2008; Mojon, 2000; Ozdemir, 2009). The studies that focus on pass-through in the Euro zone use nonharmonized retail interest rate statistics (see de Bondt, 2002, 2005; Heinemann & Schüller, 2002; Mojon, 2000; Sander & Kleimeier, 2002, 2004; Toolsema, Sturm, & de Haan, 2002). Some studies use individual retail bank data (see Cottarelli, Ferri, & Generale, 1995; De Graeve et al., 2004; Gambacorta, 2004; Weth, 2002).

Ozdemir (2009) estimates pass-through between the money market rate and bank retail rate for Turkey. There is a limited body of literature on developing countries such as Pakistan. Qayyum, Khan, and Khawaja (2005) estimate the pass-through of the treasury bill rate on the call money rate, savings deposit rate, six-month deposit rate, and lending rate. They use data for the six-month deposit rate and lending rate for the period March 1991 to December 2004, while employing the transfer function approach. Mohsin and Rivers (in press) measure the pass-through between the treasury bill rate and retail rate for Pakistan, and find that the degree of pass-through is moderately high although the pass-through is not complete. The State Bank of Pakistan presently uses the discount rate as a monetary policy tool, although it has used various other tools as well.

This study attempts to measure the pass-through between the discount rate and retail rate, using monthly data for the period November 2001 to March 2011. We use data for the weighted average lending and deposit rates for four types of banks, i.e., private domestic, foreign, nationalized, and specialized. A comparison of the pass-through in the case of various categories of banks' retail rates and discount rates will be an interesting extension of ongoing research in Pakistan. …

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