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Interest Rate Pass-through and Banking Market Integration in ASEAN: A Cross Country Comparison
Presented by:
Hafeez ur Rehman CGA-070180
Supervised by: Dr. Roselee Shah Shaharudin
14th May, 2009
3
INTRODUCTIONINTRODUCTION
Interest Rate Transmission Channel Inflation Rate Targeting
Interest Rate Pass-through Short Term Pass-through Long-term Pass-through
Problem Statement and Research Questions Scope of Study Research Significance and Rationale
4
Interest Rate Channel & Inflation Targeting
Source: Bank of Thailand website: www.bot.or.th
INTRODUCTION Cont’dINTRODUCTION Cont’d
5
Interest Rate Pass-through:
The degree and the speed of adjustment for retail bank rates to monetary policy interest rate.
Short Term Pass-through Sluggish and incomplete Pass-through.1
Long Term Pass-through Normally Close to 1 i.e 100% Pass-through
Interest Rate Pass-through
1. Sander and Kleimier (2000, 2002, 2004a,2004b)
INTRODUCTION Cont’dINTRODUCTION Cont’d
6
How effective is the interest rate transmission mechanism in selected ASEAN Countries? Are Pass-through rates same for all ASEAN Countries?. How integrated is Banking Market in ASEAN?
Whether pass-through is dependent on the type of bank products under study?.
Problem Statement and Research Questions
INTRODUCTION Cont’dINTRODUCTION Cont’d
7
The study focus is on the analysis of the short-term and long-term Pass-through for the following ASEAN countries to explain the level of retail market integration in the region.
Philippines Thailand Indonesia Singapore Malaysia
Scope of Study
INTRODUCTION Cont’dINTRODUCTION Cont’d
8
Research: Significance and Rationale
No Past studies on the ASEAN retail banking market integration and cross comparison for the interest rate Pass-through among different countries.*
Increased focus on having a converged economy and a common financial structure for ASEAN.
*To the best of my knowledge, no such research work has been published in any of themajor literature sources
INTRODUCTION Cont’dINTRODUCTION Cont’d
9
Interest Rate Pass-through Two Stages.*
Policy rate → Money Market Rates (Short and long term) MM rate → Short-term/long-term deposit/loan rate
Two Approaches Cost of Fund Approach Monetary Policy Approach
LITERATURELITERATURE REVIEWREVIEW
* Balázs et-al(2006)
10
Cost of Fund Approach*
Best way to describe the second stage of the interest rate pass-through MM rate → Short-term/long-term deposit/loan rate
Factors Bank’s reliance on Money Market for fund lending MM investment acts as opportunity costs for banks MM acts as bank competitor for the consumer savings
Proxy Rate Using MM rate of equal maturities
* DeBondt(2005)
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
11
Monetary Policy Approach*
It looks directly at the relationship between policy rates and retail banking (deposit and loan) rates.
Policy rate → short-term/long-term deposit rate Policy rate → short-term/long-term lending rate
Proxy Rate Using Monthly (short term) money market rate
* Sander and Kleimeier(2004a)
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
12
Factors Influencing Pass-through Demand Elasticity for bank products Week competition in the financial sector Macroeconomic Conditions
Degree of Pass-through ~ Economic growth Degree of Pass-through ~ Inflation rate Degree of Pass-through ~ 1/interest rate volatility
Outcomes Not complete Pass-through in Long run Sluggish Pass-through in short run
Menu costs Maturity mismatch for bank products.* Customer relationship
* Weth, (2002).
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
13
Pass-through Analysis in the Recent Literature Individual Country behavior.1 Cross-country behavior.2 Policy Rate Proxy Choice. Difference in the use of Econometric Model
Cointegration-Single Equation ECM Approach.3 VAR Approach.4 Time series vs Panel Data Analysis
Difference in the Time-period covered for analysis Common Aim: Discovering the degree and speed of
adjustment of bank rates to changes in money market rates.
1. Cottarelli et al. (1995) for Italy, Moazzami (1999) for Canada and United States, Winker (1999) for Germany, Manzano and Galmes (1996) for Spain, and Bredin et al (2001) for Ireland
2. BIS (1994), Borio & Fritz (1994), Cottarelli & Kourelis (1995), Lowe (1994), Mozzami (1999), Mojon (2002), Kleimer and Sander (2000), Donnay and Degryse (2001), Toolsema et al. (2001), Espinosa- Vega and Rebucci (2003), and Bondt (2002).
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
14
Previous Research Findings
Retail rate adjustment to market interest rate changes are incomplete.
The degree and speed of Pass-through are different among different retail rates
Significant cross countries differences exist.
Enterprise Loans and Time deposits adjusts quickly, household loans and saving deposits are sticky.
** Sorensen and Werner(2006)
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
15
Research Methodology Monetary Policy Approach
Policy rate → short-term/long-term deposit rate Policy rate → short-term/long-term lending rate
Proxy Rate: Monthly (short term) money market rate
Econometric Modeling Time series Data Cointegration-Single Equation ECM Approach.1
1. Mojon (2000); Heinemann and Schüler (2002); Toolsema, Sturm and de Haan (2002); de Bondt, Mojon and Valla (2002); Sander and Kleimeier (2002 and 2004a-b), Gambacorta (2004) for the case of Italy; Weth (2002) for Germany; and De Graeve, De Jonghe and Vennet (2004) for Belgium.
LITERATURELITERATURE REVIEW Cont’dREVIEW Cont’d
16
RESEARCH METHODOLOGYRESEARCH METHODOLOGYTHEORETICAL FRAMEWORKTHEORETICAL FRAMEWORK
Interbank Offer Rate (1 month)
Fixed Deposits (3, 6, 12 months)
Saving Deposits
Bank Loans (BLR)
.
.
IndependentVariable
Dependent Variables
Variable Names
• PHIBOR
• BIBOR
• SIBOR
• JIBOR
• KLIBOR
Variable Names
• FD3
• FD6
• FD12
• SD
• BLR
17
DF-GLS, NP
KPSS
Time Series DataTime Series DataTime Series DataTime Series Data
Unit Root TestUnit Root TestUnit Root TestUnit Root Test
Phillips-Perron
Augmented DF
Dickey-Fuller
H0: Yt ~ I(1)H1: Yt ~ I(0)
H0: Yt ~ I(0)H1: Yt ~ I(1)
Non-StationarityNon-Stationarity StationarityStationarity
VAR in VAR in LevelLevel
Orders of IntegrationOrders of Integration
RESEARCH METHODOLOGYRESEARCH METHODOLOGYECONOMETRIC MODELECONOMETRIC MODEL
DifferenceDifference
ARDL ARDL Bounding Bounding
TestTest
E-GE-GJ-JJ-J
H-I KPSS H-I KPSS
The sameThe same
Cointegration TestCointegration Test
18Model SpecificationModel SpecificationModel SpecificationModel Specification
Cointegration TestCointegration TestCointegration TestCointegration Test
NoNo
VAR in VAR in differdiffer
YesYes
UECMUECM(Pesaran (Pesaran
et al., et al., 2001)2001)
VECM VECM
Unit Root TestUnit Root TestUnit Root TestUnit Root Test
StationarityStationarity
VAR in VAR in LevelLevel
EG,JJ, KPSSEG,JJ, KPSS ARDLARDL
RESEARCH METHODOLOGY Cont’dRESEARCH METHODOLOGY Cont’dECONOMETRIC MODEL Cont’dECONOMETRIC MODEL Cont’d
20
Five ASEAN CountriesPhilippines Thailand Singapore
Indonesia Malaysia
Five Banking ProductsFixed Deposits (3mth, 6mth, 12mth) Saving Deposit
Loans (Lending Rate)
Four Tests1. Unit Root Tests2. Level of Integration Tests3. Cointegration Tests4. Error Correction Modeling
DATA ANALYSISDATA ANALYSIS
21
Unit Root Test and Level of Integration: All interest rate series are Non Stationary and I(1).
Cointegration Tests: Both Granger’s and Johansen’s Test. Error Correction Modeling.
DATA ANALYSIS Cont’dDATA ANALYSIS Cont’dPhilippinesPhilippines
Pass-through Stats
Johanson Granger
Long Term Short Term Long Term Short Term
MarkupDegree of
Pass-throughRate of
Adjustment Markup
Degree of Pass-
through
Degree of Pass-
throughRate of
Adjustment
FD3 0.3462 0.7654 -0.2334 0.8426 0.6189 0.2779 -0.3170
FD6 0.6215 0.7992 -0.3042 0.8693 0.6132 0.0737 -0.3378
FD12 0.8963 0.8818 -0.2214 0.5796 0.6969 0.1736 -0.2950
SD 2.0520 0.8049 -0.3002 -0.7275 0.6394 0.1137 -0.3460
BLR -6.3567 0.4477 -0.4745 7.0629 0.3599 0.0815 -0.4990
0
4
8
12
16
20
00 01 02 03 04 05 06 07 08
BLRFD12FD3
FD6PHIBORSD
22
Unit Root Test and Level of Integration: All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test. Error Correction Modeling.
DATA ANALYSIS Cont’dDATA ANALYSIS Cont’dThailandThailand
Pass-through Stats
Johanson GrangerLong Term Short Term Long Term Short Term
MarkupDegree of
Pass-throughRate of
Adjustment MarkupDegree of
Pass-throughDegree of
Pass-throughRate of
Adjustment
FD3 -0.1115 0.6978 -0.0579 1.0512 0.3692 0.1438 -0.0581
FD6 -0.1101 0.7156 -0.0602 0.9365 0.4267 0.1643 -0.0620
FD12 0.0557 0.8650 -0.0453 1.0659 0.4728 0.1818 -0.0488
SD -0.8352 0.1441 -0.0241 1.7463 -0.1754 0.0216 -0.0231
BLR -4.5544 0.7609 -0.0492 5.8624 0.3047 0.0932 -0.0501
0
1
2
3
4
5
6
7
8
9
00 01 02 03 04 05 06 07 08
BIBORBLRFD12
FD3FD6SD
23
Unit Root Test and Level of Integration: All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test. Error Correction Modeling.
DATA ANALYSIS Cont’dDATA ANALYSIS Cont’dSingaporeSingapore
Pass-through Stats
Johanson Granger
Long Term Short Term Long Term Short Term
MarkupDegree of
Pass-throughRate of
Adjustment MarkupDegree of
Pass-through
Degree of Pass-
throughRate of
Adjustment
FD3 0.4788 0.6899 -0.0189 0.5652 0.1153 0.0599 -0.0208
FD6 0.5377 0.8244 -0.0180 0.7645 0.1077 0.0587 -0.0198
FD12 0.1514 0.7430 -0.0206 0.9681 0.1264 0.0732 -0.0218
SD 0.1746 0.3708 -0.0227 0.3718 0.0697 0.0393 -0.0231
BLR -5.3294 0.0485 -0.0383 5.3200 0.0538 0.0423 -0.0349
0
1
2
3
4
5
6
00 01 02 03 04 05 06 07 08
BLRFD12FD3
FD6SDSIBOR
24
Unit Root Test and Level of Integration: All interest rate series are Non Stationary and I(1).
Cointegration Tests: Both Johansen’s and Granger’s Test. Error Correction Modeling.
DATA ANALYSIS Cont’dDATA ANALYSIS Cont’dIndonesiaIndonesia
Pass-through Stats
Johanson Granger
Long Term Short Term Long Term Short Term
MarkupDegree of
Pass-throughRate of
Adjustment MarkupDegree of
Pass-through
Degree of Pass-
throughRate of
Adjustment
FD3 1.0897 1.0436 -0.2866 -0.1158 0.9578 0.1611 -0.2832
FD6 0.4446 1.0026 -0.1911 1.3105 0.8469 0.0941 -0.1871
FD12 -1.1185 0.9231 -0.1770 3.5308 0.7089 -0.0181 -0.1770
SD 2.4890 0.7408 -0.0562 -0.2605 0.5383 0.0402 -0.0569
BLR -8.8189 0.5999 -0.1129 11.2670 0.3825 0.0215 -0.1092
0
4
8
12
16
20
24
00 01 02 03 04 05 06 07 08
FD12FD3FD6
SDBLRJIBOR
25
Unit Root Test and Level of Integration: All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test (10 mth lag). Error Correction Modeling.
DATA ANALYSIS Cont’dDATA ANALYSIS Cont’dMalaysiaMalaysia
Pass-through Stats
Johanson Granger
Long Term Short Term Long Term Short Term
MarkupDegree of
Pass-throughRate of
Adjustment MarkupDegree of
Pass-through
Degree of Pass-
throughRate of
Adjustment
FD3 -3.1089 0.0176 -0.0415 3.1311 0.0103 0.2692 -0.0307
FD6 -2.0261 0.3861 -0.0454 2.6923 0.1705 0.3398 -0.0357
FD12 -4.9772 0.3661 -0.0418 4.4972 -0.2109 0.3093 -0.0312
SD -91.0116 28.8324 0.0007 4.6213 -0.8789 0.1204 -0.0024
BLR -3.1920 1.0484 -0.0383 4.7960 0.5295 0.3808 -0.0409
1
2
3
4
5
6
7
00 01 02 03 04 05 06 07 08
BLRFD12FD3
FD6KLIBORSD
26
CONCLUSIONS CONCLUSIONS 1. Interest rate Pass-through: Cross Country Comparison
Indonesia
Highest pass-through rate. Rate of adjustment is around 20% per month for fixed deposits, 6% for saving
deposits and 11% for the lending rates respectively. indicates a highly efficient interest rate transmission mechanism and a very open
economy.
Philippines Long term pass-through rate is high. Degree of pass-through rate increases with maturity of fixed deposit. Rate of adjustment is 23% per month for fixed deposits, 30% for saving deposits
and 47% for the lending rates respectively. Interest rate transmission mechanism is quite effective with banks playing a
pivotal role in the transmission of monetary policy.
27
CONCLUSIONS Cont’dCONCLUSIONS Cont’d1. Interest rate Pass-through: Cross Country Comparison
Thailand Effective long term transmission of interest rate but short run speed adjustment is
sluggish. short term adjustment rate of 5-6% for fixed deposits and lending rates, but 2%
for saving deposits. saving deposits are quite sticky and they do not change quickly in response to
the policy rate changes.
Singapore Monetary policy is not entirely based on inflation targeting. long-term pass-through is quite high (> 0.70) for fixed deposit rates but quite low
for saving deposits (0.37) and lending rates (0.048). indicates interest rate transmission mechanism in Singapore is not effective
when compared to other ASEAN countries. This can be due to high-switching costs for consumers, high competition in banking industry and their state policies.
28
CONCLUSIONS Cont’dCONCLUSIONS Cont’d1. Interest rate Pass-through: Cross Country Comparison Malaysia
Lowest pass-through rate among ASEAN Countries Often series were cointegrated using a long lag,
indicating an inefficient interest rate channel Long term pass-through rate for fixed deposits was
found to be 1%-36% and short term rate of adjustment is also at ~4%.
Does not imply that Malaysian banking and finance market is particularly inefficient. It can be indicative of a very high degree of competition in banking market or high degree of state control over banking sector.
29
CONCLUSIONS Cont’dCONCLUSIONS Cont’d2. Interest rate Pass-through: Cross Product
Comparison Fixed deposits
Higher long term Pass-through and higher speed of adjustment in the short run
Long term multiplier is closer to one for shorter maturity rates
Saving deposit and lending Sticky and do not move quickly
Consistent with economic theory and past literature
30
CONCLUSIONS Cont’dCONCLUSIONS Cont’d 3. Banking Market Integration in ASEAN
High degree of heterogeneity of pass-through of market interest rates to banking interest rates.
Both the long-run multipliers and the speed of adjustment coefficients are different between various banking products across ASEAN.
Lack of Integration of retail banking sector in ASEAN. Low level of banking market integration will make it
difficult for countries to effectively consolidate their banking sector.
31
RECOMMENDATIONSRECOMMENDATIONS
In order to achieve effective banking market integration, the reason behind Pass-through rate differences should be analyzed and addressed. (banking system, market competition, consumer behavior etc).
Further research Potential: Finding ways to close the gap between interest rate transmission
behaviors for the different countries. Studying the reason behind the persistence heterogeneity in
various banking products Extending this pass-through research for the selected countries
on the basis of common foreign currency based banking products.