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Interest Rate Pass-through and Banking Market Integration in ASEAN: A Cross Country Comparison Presented by: Hafeez ur Rehman CGA-070180 Supervised by:

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Presentation on theme: "Interest Rate Pass-through and Banking Market Integration in ASEAN: A Cross Country Comparison Presented by: Hafeez ur Rehman CGA-070180 Supervised by:"— Presentation transcript:

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

3 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 4 Interest Rate Channel & Inflation Targeting Source: Bank of Thailand website: INTRODUCTION Cont’d

5 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’d

6 6 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’d

7 7 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’d

8 8 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 the major literature sources INTRODUCTION Cont’d

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

10 10 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) LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

11 11 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) LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

12 12 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). LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

13 13 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). LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

14 14 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) LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

15 15 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 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. LITERATUREREVIEW Cont’d LITERATURE REVIEW Cont’d

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

17 17 DF-GLS, NPKPSS Time Series Data Unit Root Test Phillips-PerronAugmented DFDickey-Fuller H0: Yt ~ I(1) H1: Yt ~ I(0) H0: Yt ~ I(0) H1: Yt ~ I(1) Non-StationarityStationarity VAR in Level Orders of Integration RESEARCH METHODOLOGY ECONOMETRIC MODEL Difference ARDL Bounding Test E-GJ-J H-I KPSS The same Cointegration Test

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

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

20 20 Five ASEAN Countries PhilippinesThailandSingapore Indonesia Malaysia Five Banking Products Fixed Deposits (3mth, 6mth, 12mth) Saving Deposit Loans (Lending Rate) Four Tests 1. Unit Root Tests 2. Level of Integration Tests 3. Cointegration Tests 4. Error Correction Modeling DATA ANALYSIS

21 21 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’d Philippines Pass-through Stats JohansonGranger Long TermShort TermLong TermShort Term Markup Degree of Pass-through Rate of AdjustmentMarkup Degree of Pass- through Rate of Adjustment FD FD FD SD BLR

22 22 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’d Thailand Pass-through Stats JohansonGranger Long TermShort TermLong TermShort Term Markup Degree of Pass-through Rate of AdjustmentMarkup Degree of Pass-through Rate of Adjustment FD FD FD SD BLR

23 23 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’d Singapore Pass-through Stats JohansonGranger Long TermShort TermLong TermShort Term Markup Degree of Pass-through Rate of AdjustmentMarkup Degree of Pass-through Rate of Adjustment FD FD FD SD BLR

24 24 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’d Indonesia Pass-through Stats JohansonGranger Long TermShort TermLong TermShort Term Markup Degree of Pass-through Rate of AdjustmentMarkup Degree of Pass-through Rate of Adjustment FD FD FD SD BLR

25 25 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’d Malaysia Pass-through Stats JohansonGranger Long TermShort TermLong TermShort Term Markup Degree of Pass-through Rate of AdjustmentMarkup Degree of Pass-through Rate of Adjustment FD FD FD SD BLR

26 26 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.

27 27 CONCLUSIONS Cont’d 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 28 CONCLUSIONS Cont’d 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 29 CONCLUSIONS Cont’d 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 30 CONCLUSIONS Cont’d 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 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.

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