1. Interest Rate Pass-through and Banking Market Integration in ASEAN: A Cross Country Comparison
Presented by:
Hafeez ur Rehman CGA
Supervised by:
Dr. Roselee Shah Shaharudin
14th May, 2009

2. Conclusions and Recommendations
PRESENTATION OUTLINE 1
Introduction
Research Objectives
Scope of Study 2
Literature Review 3
Research Methodology
Econometric Model 4
Data Analysis 5
Conclusions and Recommendations 5

3. INTRODUCTION 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
INTRODUCTION Cont’d
Interest Rate Channel & Inflation Targeting
Source: Bank of Thailand website:

5. Interest Rate Pass-through
INTRODUCTION Cont’d
Interest Rate Pass-through
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
1. Sander and Kleimier (2000, 2002, 2004a,2004b)

6. Problem Statement and Research Questions
INTRODUCTION Cont’d
Problem Statement and Research Questions
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?.

7. INTRODUCTION 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.
Philippines
Thailand
Indonesia
Singapore
Malaysia

8. Research: Significance and Rationale
INTRODUCTION Cont’d
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 the
major literature sources

9. LITERATURE REVIEW 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
* Balázs et-al(2006)

10. LITERATURE REVIEW Cont’d
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)

11. LITERATURE 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 rate
Policy rate → short-term/long-term lending rate
Proxy Rate
Using Monthly (short term) money market rate
* Sander and Kleimeier(2004a)

12. LITERATURE REVIEW Cont’d
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).

13. LITERATURE REVIEW Cont’d
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).

14. LITERATURE REVIEW Cont’d
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)

15. LITERATURE REVIEW Cont’d
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.

16. RESEARCH METHODOLOGY THEORETICAL FRAMEWORK
Dependent Variables
Fixed Deposits
(3, 6, 12 months)
Variable Names
FD3
FD6
FD12 SD
BLR .
Interbank Offer Rate
(1 month)
Saving Deposits
Independent
Variable
Variable Names
PHIBOR
BIBOR
SIBOR
JIBOR
KLIBOR
Bank Loans
(BLR)

17. RESEARCH METHODOLOGY ECONOMETRIC MODEL
Time Series Data
Unit Root Test
Non-Stationarity
Dickey-Fuller
Stationarity
Augmented DF
Orders of Integration
H0: Yt ~ I(1)
H1: Yt ~ I(0)
VAR in Level
The same
Difference
Phillips-Perron
E-G
J-J
H-I KPSS
ARDL Bounding Test
DF-GLS, NP
H0: Yt ~ I(0)
H1: Yt ~ I(1)
KPSS
Cointegration Test

18. RESEARCH METHODOLOGY Cont’d ECONOMETRIC MODEL Cont’d
Unit Root Test
Stationarity
Cointegration Test
Yes No
EG,JJ, KPSS
ARDL
VAR in Level
VECM
UECM
(Pesaran et al., 2001)
VAR in differ
Model Specification

19. RESEARCH METHODOLOGY Cont’d Sources of Data
DataBase
Website
Monitory Authority of Singapore
Bank Negara Malaysia
Bank of Thailand
Central Bank of Philippines
Bank Indonesia
Bloomberg
Econometric Software Packages: EViews, SPSS.

20. DATA ANALYSIS Five ASEAN Countries Philippines Thailand Singapore
Indonesia Malaysia
Five Banking Products
Fixed Deposits (3mth, 6mth, 12mth) Saving Deposit Loans (Lending Rate)
Four Tests
Unit Root Tests
Level of Integration Tests
Cointegration Tests
Error Correction Modeling

21. Degree of Pass-through
DATA ANALYSIS Cont’d Philippines
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.
Pass-through Stats
Johanson
Granger
Long Term
Short Term
Markup
Degree of Pass-through
Rate of Adjustment
FD3
0.3462
0.7654
0.8426
0.6189
0.2779
FD6
0.6215
0.7992
0.8693
0.6132
0.0737
FD12
0.8963
0.8818
0.5796
0.6969
0.1736 SD
2.0520
0.8049
0.6394
0.1137
BLR
0.4477
7.0629
0.3599
0.0815

22. Degree of Pass-through
DATA ANALYSIS Cont’d Thailand
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.
Pass-through Stats
Johanson
Granger
Long Term
Short Term
Markup
Degree of Pass-through
Rate of Adjustment
FD3
0.6978
1.0512
0.3692
0.1438
FD6
0.7156
0.9365
0.4267
0.1643
FD12
0.0557
0.8650
1.0659
0.4728
0.1818 SD
0.1441
1.7463
0.0216
BLR
0.7609
5.8624
0.3047
0.0932

23. Degree of Pass-through
DATA ANALYSIS Cont’d Singapore
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.
Pass-through Stats
Johanson
Granger
Long Term
Short Term
Markup
Degree of Pass-through
Rate of Adjustment
FD3
0.4788
0.6899
0.5652
0.1153
0.0599
FD6
0.5377
0.8244
0.7645
0.1077
0.0587
FD12
0.1514
0.7430
0.9681
0.1264
0.0732 SD
0.1746
0.3708
0.3718
0.0697
0.0393
BLR
0.0485
5.3200
0.0538
0.0423

24. Degree of Pass-through
DATA ANALYSIS Cont’d Indonesia
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.
Pass-through Stats
Johanson
Granger
Long Term
Short Term
Markup
Degree of Pass-through
Rate of Adjustment
FD3
1.0897
1.0436
0.9578
0.1611
FD6
0.4446
1.0026
1.3105
0.8469
0.0941
FD12
0.9231
3.5308
0.7089 SD
2.4890
0.7408
0.5383
0.0402
BLR
0.5999
0.3825
0.0215

25. Degree of Pass-through
DATA ANALYSIS Cont’d Malaysia
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.
Pass-through Stats
Johanson
Granger
Long Term
Short Term
Markup
Degree of Pass-through
Rate of Adjustment
FD3
0.0176
3.1311
0.0103
0.2692
FD6
0.3861
2.6923
0.1705
0.3398
FD12
0.3661
4.4972
0.3093 SD
0.0007
4.6213
0.1204
BLR
1.0484
4.7960
0.5295
0.3808

26. 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’d 1. 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’d 1. 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’d 2. 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’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. RECOMMENDATIONS
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.

32. Thank You !