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Impact of bank competition on the interest rate pass-through in the euro area

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Abstract:

This article analyses the impact of loan market competition on the interest rates applied by euro area banks to loans during the period 1994–2004, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products, in line with expectations. This result implies that stronger competition causes both lower bank interest rates and a stronger pass-through of market rate changes into bank rates. Evidence of the latter is also presented by our Error Correction Model (ECM) for bank rates. Further, banks compensate income losses from increased loan market competition by offering lower deposit rates. Our findings with respect to the loan market rates have important monetary policy implications, as they suggest that measures to promote competition in the European banking sector are likely to render the monetary policy transmission mechanism more effective.

Keywords: C23; D4; E50; G21; L10; bank lending and funding; competition; error-correction model; interest rate spreads; monetary transmission

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036846.2011.617697

Affiliations: 1: Netherlands Bureau for Economic Policy Analysis (CPB), The Hague, The Netherlands 2: European Central Bank, Directorate General Financial Stability, Frankfurt, Germany 3: De Nederlandsche Bank, Supervisory Policy Division, PO Box 98, NL-1000 AB Amsterdam, The Netherlands 4: International Economics and International Relations Department, Banco de España,Madrid, Spain

Publication date: April 1, 2013

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