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1Interest Rate Pass-through and Banking Market Integration in ASEAN: A Cross Country Comparison Presented by:Hafeez ur Rehman CGASupervised by:Dr. Roselee Shah Shaharudin14th May, 2009
2Conclusions and Recommendations PRESENTATION OUTLINE1IntroductionResearch ObjectivesScope of Study2Literature Review3Research MethodologyEconometric Model4Data Analysis5Conclusions and Recommendations5
3INTRODUCTION Interest Rate Transmission Channel Inflation Rate TargetingInterest Rate Pass-throughShort Term Pass-throughLong-term Pass-throughProblem Statement and Research QuestionsScope of StudyResearch Significance and Rationale
4Interest Rate Channel & Inflation Targeting INTRODUCTION Cont’dInterest Rate Channel & Inflation TargetingSource: Bank of Thailand website:
5Interest Rate Pass-through INTRODUCTION Cont’dInterest Rate Pass-throughInterest Rate Pass-through:The degree and the speed of adjustment for retail bank rates to monetary policy interest rate.Short Term Pass-throughSluggish and incomplete Pass-through.1Long Term Pass-throughNormally Close to 1 i.e 100% Pass-through1. Sander and Kleimier (2000, 2002, 2004a,2004b)
6Problem Statement and Research Questions INTRODUCTION Cont’dProblem Statement and Research QuestionsHow 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?.
7INTRODUCTION Cont’d Scope of Study 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.PhilippinesThailandIndonesiaSingaporeMalaysia
8Research: Significance and Rationale INTRODUCTION Cont’dNo 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
9LITERATURE REVIEW Interest Rate Pass-through Two Stages.* Policy rate → Money Market Rates (Short and long term)MM rate → Short-term/long-term deposit/loan rateTwo ApproachesCost of Fund ApproachMonetary Policy Approach* Balázs et-al(2006)
10LITERATURE REVIEW Cont’d Cost of Fund Approach*Best way to describe the second stage of the interest rate pass-throughMM rate → Short-term/long-term deposit/loan rateFactorsBank’s reliance on Money Market for fund lendingMM investment acts as opportunity costs for banksMM acts as bank competitor for the consumer savingsProxy RateUsing MM rate of equal maturities* DeBondt(2005)
11LITERATURE REVIEW Cont’d 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 ratePolicy rate → short-term/long-term lending rateProxy RateUsing Monthly (short term) money market rate* Sander and Kleimeier(2004a)
12LITERATURE REVIEW Cont’d Factors Influencing Pass-throughDemand Elasticity for bank productsWeek competition in the financial sectorMacroeconomic ConditionsDegree of Pass-through ~ Economic growthDegree of Pass-through ~ Inflation rateDegree of Pass-through ~ 1/interest rate volatilityOutcomesNot complete Pass-through in Long runSluggish Pass-through in short runMenu costsMaturity mismatch for bank products.*Customer relationship* Weth, (2002).
13LITERATURE REVIEW Cont’d Pass-through Analysis in the Recent LiteratureIndividual Country behavior.1Cross-country behavior.2Policy Rate Proxy Choice.Difference in the use of Econometric ModelCointegration-Single Equation ECM Approach.3VAR Approach.4Time series vs Panel Data AnalysisDifference in the Time-period covered for analysisCommon 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 Ireland2. 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).
14LITERATURE REVIEW Cont’d Previous Research FindingsRetail rate adjustment to market interest rate changes are incomplete.The degree and speed of Pass-through are different among different retail ratesSignificant cross countries differences exist.Enterprise Loans and Time deposits adjusts quickly, household loans and saving deposits are sticky.** Sorensen and Werner(2006)
15LITERATURE REVIEW Cont’d Research MethodologyMonetary Policy ApproachPolicy rate → short-term/long-term deposit ratePolicy rate → short-term/long-term lending rateProxy Rate:Monthly (short term) money market rateEconometric ModelingTime series DataCointegration-Single Equation ECM Approach.11. 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.
17RESEARCH METHODOLOGY ECONOMETRIC MODEL Time Series DataUnit Root TestNon-StationarityDickey-FullerStationarityAugmented DFOrders of IntegrationH0: Yt ~ I(1)H1: Yt ~ I(0)VAR in LevelThe sameDifferencePhillips-PerronE-GJ-JH-I KPSSARDL Bounding TestDF-GLS, NPH0: Yt ~ I(0)H1: Yt ~ I(1)KPSSCointegration Test
18RESEARCH METHODOLOGY Cont’d ECONOMETRIC MODEL Cont’d Unit Root TestStationarityCointegration TestYesNoEG,JJ, KPSSARDLVAR in LevelVECMUECM(Pesaran et al., 2001)VAR in differModel Specification
19RESEARCH METHODOLOGY Cont’d Sources of Data DataBaseWebsiteMonitory Authority of SingaporeBank Negara MalaysiaBank of ThailandCentral Bank of PhilippinesBank IndonesiaBloombergEconometric Software Packages: EViews, SPSS.
20DATA ANALYSIS Five ASEAN Countries Philippines Thailand Singapore Indonesia MalaysiaFive Banking ProductsFixed Deposits (3mth, 6mth, 12mth) Saving Deposit Loans (Lending Rate)Four TestsUnit Root TestsLevel of Integration TestsCointegration TestsError Correction Modeling
21Degree of Pass-through DATA ANALYSIS Cont’d PhilippinesUnit 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.Pass-through StatsJohansonGrangerLong TermShort TermMarkupDegree of Pass-throughRate of AdjustmentFD30.34620.76540.84260.61890.2779FD60.62150.79920.86930.61320.0737FD120.89630.88180.57960.69690.1736SD2.05200.80490.63940.1137BLR0.44777.06290.35990.0815
22Degree of Pass-through DATA ANALYSIS Cont’d ThailandUnit Root Test and Level of Integration:All interest rate series are Non Stationary and I(1).Cointegration Tests: Johansen’s Test.Error Correction Modeling.Pass-through StatsJohansonGrangerLong TermShort TermMarkupDegree of Pass-throughRate of AdjustmentFD30.69781.05120.36920.1438FD60.71560.93650.42670.1643FD120.05570.86501.06590.47280.1818SD0.14411.74630.0216BLR0.76095.86240.30470.0932
23Degree of Pass-through DATA ANALYSIS Cont’d SingaporeUnit Root Test and Level of Integration:All interest rate series are Non Stationary and I(1).Cointegration Tests: Johansen’s Test.Error Correction Modeling.Pass-through StatsJohansonGrangerLong TermShort TermMarkupDegree of Pass-throughRate of AdjustmentFD30.47880.68990.56520.11530.0599FD60.53770.82440.76450.10770.0587FD120.15140.74300.96810.12640.0732SD0.17460.37080.37180.06970.0393BLR0.04855.32000.05380.0423
24Degree of Pass-through DATA ANALYSIS Cont’d IndonesiaUnit 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.Pass-through StatsJohansonGrangerLong TermShort TermMarkupDegree of Pass-throughRate of AdjustmentFD31.08971.04360.95780.1611FD60.44461.00261.31050.84690.0941FD120.92313.53080.7089SD2.48900.74080.53830.0402BLR0.59990.38250.0215
25Degree of Pass-through DATA ANALYSIS Cont’d MalaysiaUnit 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.Pass-through StatsJohansonGrangerLong TermShort TermMarkupDegree of Pass-throughRate of AdjustmentFD30.01763.13110.01030.2692FD60.38612.69230.17050.3398FD120.36614.49720.3093SD0.00074.62130.1204BLR1.04844.79600.52950.3808
26CONCLUSIONS 1. Interest rate Pass-through: Cross Country Comparison IndonesiaHighest 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.PhilippinesLong 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.
27CONCLUSIONS Cont’d 1. Interest rate Pass-through: Cross Country Comparison ThailandEffective 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.SingaporeMonetary 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.
28CONCLUSIONS Cont’d 1. Interest rate Pass-through: Cross Country Comparison MalaysiaLowest pass-through rate among ASEAN CountriesOften series were cointegrated using a long lag, indicating an inefficient interest rate channelLong 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.
29CONCLUSIONS Cont’d 2. Interest rate Pass-through: Cross Product Comparison Fixed depositsHigher long term Pass-through and higher speed of adjustment in the short runLong term multiplier is closer to one for shorter maturity ratesSaving deposit and lendingSticky and do not move quicklyConsistent with economic theory and past literature
30CONCLUSIONS 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.
31RECOMMENDATIONSIn 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 productsExtending this pass-through research for the selected countries on the basis of common foreign currency based banking products.