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

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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

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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

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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

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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)

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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.

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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.

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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.

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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

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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.

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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.