Title: Modeling interest rate pass through with heterogeneous bank loans
Authors: Arvid Raknerud - Statistics Norway (Norway) [presenting]
Bjorn Helge Vatne - Norges Bank (Norway)
Paul Mizen - University of Nottingham (United Kingdom)
Abstract: Studies of interest rate pass-through make a common assumption that bank loans are homogenous products priced in an imperfectly competitive framework. We explore the implications of relaxing that assumption. We argue that, in principle, the products banks offer their customers are heterogeneous and not so different from the goods and services offered by the non-bank private sector; therefor rate setting could be modeled using a modified Dixit-Stiglitz model. Funding costs are determined by money market rates and spreads on bank bonds that vary across banks, whereas retail rates are mark-ups over marginal funding costs. Applying our model to data from Norway, our results regarding long-term pass-through show that it is incomplete, with a 100bp increase in the market rate leading to a 89bp increase in household mortgage rates and a 79bp increase in business loan rates on average. We also find that forward NIBOR rates and spreads on bonds have a significant impact on retail rate setting, with corporate loan rates varying much more across banks than mortgage rates do. Almost 60 percent of the between-bank variation in corporate loan rates and 40 percent in household mortgage rates can be explained by bank-fixed effects, whereas, for both types of loans, almost 20 percent of the between-bank variation in lending rates is due to either observed differences in spreads or differences in pass-through coefficients across banks.