A Theoretical and Empirical Analysis of Interest rate pass-through in India with Regulatory Requirements

Jugnu Ansari
1.969 835


Özet: This study provides a theoretical and empirical analysis of optimal loan pricing by the commercial banks in a regulated environment that could relate to some developing and emerging market economies. Regulatory requirements could impinge on banks’ balance sheet and thus, influence their optimal loan pricing response to the policy rate. In such a situation, for an effective transmission mechanism through the interest rate channel, a calibrated approach may be required; changes in the policy rate to be accompanied by changes in the regulatory parameters to achieve desired changes in the banks’ lending rate. Theoretical analysis brought to the fore various critical insights. Three major insights are as follows. First, there can be a trade-off between regulation and effectiveness of transmission mechanism and competitiveness of the loan market. Second, theoretically it is possible for banks to engage in subsidisation of loans against investment in risk free government securities. Third, the capital market could be linked to monetary transmission mechanism if banks were subject to a required return on their capital base. These theoretical perspectives have implications for bank regulation and policy purposes.

Anahtar kelimeler

Money, Interest rate, Credit, monetary policy, Firm objective, Micro theory of pricing, mathematical economics, financial economics

Tam metin:



Ansari, J. and Goyal, A., 2011. Competition in the Banking Sector and Monetary Transmission Mechanism: An

Empirical Analysis of Interest Rate Pass-through in India. Mimeo. Afanasieff T., P. Lhacer, and M. Nakane. 2002. “The Determinants of Bank Interest Spreads in Brazil.” Working

Paper, Banco Central Do Brazil, Brasilia. Allen, L. (1988), “The Determinants of Bank Interest Margins: A Note”, Journal of Financial and Quantitative analysis, 23.

Allen, F., and Santomero, A. M.(2001), “What Do Financial intermediaries Do?”, Journal of Banking and Finance, 25 (2).

Altunbas, Y., Evans, L and Molyneux, P. (2001), "Bank Ownership and Efficiency", Journal of Money, Credit and Banking, vol. 33(4), 26-54.

Amir, R. (2003), “Market Structure, Scale Economies and Industry Performance”, CORE Discussion Paper Series 2003/

Angbazo, L. (1997): “Commercial Bank Net Interest Margins, Default Risk, Interest-Rate Risk, and off-Balance Sheet

Banking”, Journal of Banking and Finance, 21, 55-87. Arellano, M., and Bond, S. (1991), “Some Tests of Specification for Panel Data: Monte-Carlo Evidence and an

Application to Employment Equation”, Review of Economic Studies, 58. Arellano, M., and Bover, O. (1995), “Another Look at the instrumental-Variable Estimation of Error Components

Models”, Journal of Econometrics, 68, 29--52. Athanasoglou, P., S. Brissimis and M. Delis (2008), “Bank-Specific, industry-Specific and Macroeconomic

Determinants of Bank Profitability”, Working Paper Series 25, Bank of Greece. Barajas, A., R. Steiner, and N. Salazar (1999): “Interest Spreads in Banking in Colombia 1974-96”, IMF Staff Papers, 46, 196-224.

Beck, Thorsten & Hesse, Heiko (2009), "Why are interest spreads so high in Uganda?," Journal of Development Economics, 88(2), pages 192-204

Bencivenga, V. R. and Bruce D. Smith (1991), “Financial intermediation and endogenous growth”, The Review of

Economic Studies, Vol. 58, 195-209

Berger, A.N. (1995), “The Profit-Structure Relationship in Banking - Tests of Market-Power and Efficiency-Structure

Hypotheses”, Journal of Money, Credit and Banking, 27, P. 404-431. Bikker, J. and Hu, H. (2002), “Cyclical Patterns in Profits, Provisioning and Lending of Banks and Pro-cyclicality of the New Basel Capital Requirements”, Banca Nazionale Del Lavoro Quarterly Review, 55, 143–175.

Blundell, R., and Bond, S.(1997), “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models”,

Discussion Paper, No 97-07. University College London. Bond, S.R and F. Windmeijer(2002), “Finite sample inference for GMM Estimators in linear panel data models”,

Cemmap Working Paper series No. CWP04/02, Institute of Fiscal Studies, London Boone, J. (2008), “ A new way to measure competition”,The Economic Journal, 188: 1245-1261.

Brock, P. L., and L. Rojas-Suarez (2000), “Understanding the Behavior of Bank Spreads in Latin America”, Journal of Development Economics, 63, 113-134.

Brock, P. and Franken, H. (2002), “Bank Interest Margins meet Interest Rate Spreads: How Good is Balance Sheet

Data for analyzing the Cost of Financial intermediation?” mimeo Bulow, J. and Klemperer, P. (1999), “Prices and the winner’s curse”, RAND Journal of Economics, vol. 33 (1),1–21.

Carbó, S. And Rodríguez, F. (2005). “Pricing Strategies in European Banking: Specialization, Technology and intertemporal Smoothing, in Balling”, M., Lierman, F., Mullineux, A.W. (Eds.), Competition and Profitability in

European Financial Services, Routledge Studies in the European Economy, Routledge, London. Chirwa, E. W. and Mlachila, M. (2004), “Financial Reforms and Interest Rate Spreads in the Commercial Banking

System in Malawi”, IMF Staff Papers, 51(1), 96-122

Claeys, S., and Vennet, V.R. (2008). Determinants of Bank Interest Margins in Central and Eastern Europe: A

Comparison With the West. Economic Systems 32 (2), 197–216. Demirguc-Kunt, A., and H. Huizinga (1999), “Determinants of Commercial Bank Interest Margins and Profitability:

Some international Evidence”. World Bank Economic Review, 13, 379-408. Demirguc-Kunt, Asli, Laeven, Luc, Levine, Ross (2004),“Regulations, Market Structure, institutions, and the Cost of

Financial intermediation”, Journal of Money, Credit and Banking, 36(3 Part 2), 593-622. Dhal, S. (2010), ‘Regulatory Requirements and Commercial Banks’ Lending rate: Some Theoretical Perspectievs’,

Banks and Bank Systems, 5(2). Doliente, J.S. (2003), “Determinants of Bank Net Interest Margins of Southeast Asia”, Mimeo University of the Philippines.

English, W., B. (2002), ̏ Interest Rate Risk and Bank Net Interest Margins”, BIS Quarterly Review, 67-82.

Estrada D, Gomez E, Orozco (2006), “Determinants of interest margins in Colombia”, Borradores de Economia 393,

Banco de la Republica de Colombia. Flannery, M.C. (1989), “Capital Regulation and insured Banks's Choice of individual Loan Default Rates”, Journal of

Monetary Economics, No. 24, 235-58. Gambacorta, L., (2008), “How Do Banks Set Interest Rates?”, European Economic Review, 52 (5), 792–819.

Gambacorta, L., Mistrulli, P. E. (2004), “Does Bank Capital Affect Lending Behavior?”, Journal of Financial

Intermediation, 13 (4), 436–457. Hamadi, H., and Awdeh, A. (2012), “The Determinants of Bank Net Interest Margin: Evidence from the Lebanese

Banking Sector”, Journal of Money, Investment and Banking, 23, 85-98. Ho, T. S. Y., and A. Saunders (1981), “The Determinants of Bank Interest Margins: theory and Empirical Evidence”,

Journal of Financial and Quantitative analysis, 16, 581-600. Hossain, M. (2010), “Financial Reforms and Persistently High Bank Interest Spreads in Bangladesh: Pitfalls in

Institutional Development? “, February, MPRA Paper No. 24755,

Klein, M.(1971) “A Theory of the Banking Firm”, Journal of Money, Credit and Banking, 3(2), 205-218.

Lago-González, R. and Salas-Fumás, V. (2005), “Market Power and Bank Interest Rate Adjustments”, Banco De

España, Documentos De Trabajo, N. 539. Lerner, E. M. (1981), “Discussion: the Determinants of Banks Interest Margins: Theory and Empirical Evidence”,

Journal of Financial and Quantitative Analysis, Vol. XVI, No. 4., 601-602. Levine, R. (2002), “Bank-Based or Market-Based Financial Systems, Which Is Better?”, Journal of Financial intermediation, 11, 265--301.

Leuvensteijn, V, M., J.A. Bikker, A. van Rixtel, and C. Kok Sorensen (2007), “A new approach tomeasure competition in the loan markets of the euro area”, ECB Working Paper Series No. 768.

Levine, R.(1997), “Financial Development and Economic Growth: Views and Agenda”, Journal of Economic Literature, Vol. 35, 688-726

Liebeg and Schwaiger , (2007), “Determinants of Bank Interest Margins in Central and Eastern Europe”, Financial

Stability Report, No 14, Oesterreichische Nationalbank (Central Bank of Austria) Liebeg, D. and M. S. Schwaiger (2007), “What Drives the Interest Rate Margin Decline in EU Banking – the Case of

Small Local Banks”. Kredit and Kapital. Mannasoo, K. (2012), “Determinants of bank interest spread in Estonia”, Bank of Estonia Working Paper Series, WP No. 2012-1, Bank of Estonia.

Mendoza, Patricia (1997), “The Cost of Commercial Bank Credit in Belize: Contributing

Factors and Policy Implications,” Research Department, Central Bank of Belize. Maudos, J. and De Guevara, F. J. (2002). “Factors Explaining the Evolution of the Interest Margin in the Banking

Sectors of the European Union. Instituto Valenciano De Investigaciones Economicas (IVIE). Mimeo. Maudos, J., and De Guevara, F. J. (2004), “Factors Explaining the Interest Margin in the Banking Sectors of the European Union”, Journal of Banking and Finance, 28 (9), 2259–2281.

Maudos, J. and De Guevara, F. J. (2007), “The Cost of Market Power in Banking: Social Welfare Loss vs. Cost

Inefficiency”, Journal of Banking and Finance, 31 (7), 2103–2125.

Maudos, J., and Solísc, L. (2009), “The Determinants of Net Interest income in the Mexican Banking System: an

Integrated Model”, Journal of Banking and Finance, 33 (10), 1920–1931.

Mcshane, R. W., and Sharpe, I. G. (1985) “A Time Series/Cross Section analysis of the Determinants of Australian

Trading Bank Loan/Deposit Interest Margins: 1962-1981”, Journal of Banking and Finance, 9, 115-136.

Merkl, C., Stolz, S. (2009), “Banks' Regulatory Buffers, Liquidity Networks and Monetary Policy Transmission”, Applied Economics, 41 (16).

Monti, M. (1972), “Deposit, Credit and Interest Rate Determination under alternative Bank Objective Functions”, in

Karl Shell and Giorgio P. Szego, Eds., Mathematical Methods in Investment and Finance, North-Holland, Amsterdam, 431-4

Naceur, S. B. Goaied, M. (2004),"The value relevance of accounting and financial information: panel data evidence",

Applied Financial Economics, 14(17), 1219-1224.

Naceur, S. B. Goaied, M. (2008), “The Determinants of Commercial Bank Interest Margin and Profitability: Evidence from Tunisia”, Frontiers in Finance and Economics, 5 (1): 106–130

Nickell, S. (1985), “Error Correction, Partial Adjustment, and All That: An Expository Note”, Oxford Bulletin of

Economics and Statistics, 47(2), 119-129. Pallage, S.J. (1991), "An econometric study of the Belgian banking sector in terms of scale and scope economies",

Brussels Economic Review, vol. 130, 125-143. Poirson, H. (2009), ‘Monetary Policy: Communication and Transparency”, Chapter 10 in India: Managing Financial

Globalization and Growth” ed. by K. Kochhar and C. Kramer (2009, International Monetary Fund).

Roodman, D. (2009), "A Note on the Theme of Too Many Instruments", Oxford Bulletin of Economics and Statistics, 71(1), 135-158.

Saunders, A., and L. Schumacher (2000), “The Determinants of Bank Interest Rate Margins: an international Study”,

Journal of international Money and Finance, 19, 813-832. Stiglitz, J. (1989), “Imperfect information in the product market”, p. 769-847 in: R. Schmalen-see, R. Willig (Eds.),

Handbook of Industrial Organization Vol. I. Amsterdam. Stiroh, K. (2004), “Diversification in Banking: Is Non-Interest Income the Answer?”, Journal of Money,Credit and Banking 36, 853--882.

Stiroh, K., and Rumble, A. (2006), “The Dark Side of Diversification: the Case of US Financial Holding Companies”,

Journal of Banking and Finance, 30, 2131–2161

Salas, V., and J. Saurina (2002), “Credit Risk in Two Institutional Regimes: Spanish Commercial and Savings Banks,”

Journal of Financial Services Research 22 (3), 203–24. Scholnick, B. (1991), “Testing a Disequilibrium Model of Lending Rate Determination: The Case of Malaysia.” IMF

Working Paper 84. International Monetary Fund, Washington. Segura, A., and Suarez, J. (2012), “Dynamic Maturity Transformation”, Working Paper, CEMFI.

Van Leuvensteijn, M., Sorensen, C. K., Bikker, J.A. and Van Rixtel, A. M. (2008), “Impact of Bank Competition on the Interest Rate Pass-Through in the Euro Area”, European Central Bank Working Paper Series, No. 885.

Vennet, V. R. (1998), “Cost and Profit Dynamics in Financial Conglomerates and Universal Banks in Europe”, Paper

Presented at the SUERF/CFS Colloquium, Frankfurt, 15–17 October. Verbeek, M. (2008), “A Guide to Modern Econometrics”, John Wiley &Sons,Ltd. 3rd Edition.

Williams, B. (2007), “Factors Determining Net Interest Margins in Australia: Domestic and Foreign Banks,”

Financial Markets, Institutions and Instruments, 16(3),145-165. Windmeijer, F. (2005), “A finite sample correction for the variance of linear efficient two-step GMM estimators”,

Journal of Econometrics, 126(1). Winker, P. (1999), “Sluggish Adjustment of Interest Rates and Credit Rationing: An Application of Unit Root Testing and Error Correction Modeling.” Applied Economics 31(3), 267–77.

Wong, K. P. (1997), “The Determinants of Bank Interest Margins Under Credit and Interest Rate Risks”, Journal of

Banking and Finance, 21, 251-271. Zarruk, E. R. (1989), “Bank Spread with Uncertain Deposit Level and Risk Aversion”, Journal of Banking and Finance, 13, 797-810.

Zarruk, E. R. and Madura, J. (1992), “Optimal Bank Interest Margin Under Capital Regulation and Deposit

Insurance”, Journal of Financial and Quantitative Analysis, 27 (1), 143-149.

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 License.