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
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
3
INTRODUCTION Cont’d
Interest Rate Channel & Inflation Targeting
Source: Bank of Thailand website: www.bot.or.th
4
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

Sluggish and incomplete Pass-through.1
 Long

Term Pass-through
Term Pass-through
Normally Close to 1 i.e 100% Pass-through
1. Sander and Kleimier (2000, 2002, 2004a,2004b)
5
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?.
6
INTRODUCTION Cont’d
Scope of Study

The study focus is on the analysis of the shortterm 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
7
INTRODUCTION Cont’d
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
8
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)
9
LITERATURE REVIEW Cont’d
Cost of Fund Approach*
Best way to describe the second stage of the interest
rate pass-through


Factors




MM rate → Short-term/long-term deposit/loan rate
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)
10
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)
11
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).
12
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).
13
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)
14
LITERATURE REVIEW Cont’d

Research Methodology
 Monetary


Policy rate → short-term/long-term deposit rate
Policy rate → short-term/long-term lending rate
 Proxy


Policy Approach
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.
15
RESEARCH METHODOLOGY
THEORETICAL FRAMEWORK
Dependent Variables
Fixed Deposits
(3, 6, 12 months)
Interbank Offer Rate
(1 month)
.
.
Saving Deposits
Variable Names
•
FD3
•
FD6
•
FD12
•
SD
•
BLR
Independent
Variable
Variable Names
•
PHIBOR
•
BIBOR
•
SIBOR
•
JIBOR
•
KLIBOR
Bank Loans
(BLR)
16
RESEARCH METHODOLOGY
ECONOMETRIC MODEL
Time Series Data
Unit Root Test
Non-Stationarity
Stationarity
Dickey-Fuller
Orders of Integration
Augmented DF
The same
Difference
Phillips-Perron
E-G
J-J
H-I KPSS
DF-GLS, NP
ARDL
Bounding
KPSS
Test
H0: Yt ~ I(1)
H1: Yt ~ I(0)
VAR in
Level
H0: Yt ~ I(0)
H1: Yt ~ I(1)
Cointegration Test
17
RESEARCH METHODOLOGY Cont’d
ECONOMETRIC MODEL Cont’d
Unit Root Test
Stationarity
Cointegration Test
Yes
EG,JJ, KPSS
VECM
No
ARDL
UECM
(Pesaran
et al.,
2001)
VAR in
differ
Model Specification
VAR in
Level
18
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
1.
2.
3.
4.
Unit Root Tests
Level of Integration Tests
Cointegration Tests
Error Correction Modeling
20
DATA ANALYSIS Cont’d
Philippines

20
Unit Root Test and Level of Integration:
16
All interest rate series are Non Stationary and I(1).
Cointegration Tests: Both Granger’s and Johansen’s Test.
12
 Error Correction Modeling.

8
Johanson
Long Term
4
Pass-through
Stats
Markup
FD3
0.3462
FD6
01 0.6215 02
FD12
0
00
Degree of
Pass-through
Granger
Short Term
Rate of
Adjustment
Long Term
Markup
Degree of
Passthrough
Short Term
Degree of
Passthrough
Rate of
Adjustment
0.7654
-0.2334
0.8426
0.6189
0.2779
-0.3170
0.799203
-0.3042
040.8693
0.6132
05
0.0737
06
-0.3378
07
0.8963
0.8818
-0.2214
0.5796
0.6969
0.1736
-0.2950
SD
2.0520
BLR-0.3002
0.8049
-0.7275
BLR
-6.3567
FD12
0.4477
-0.4745
FD3
7.0629
FD6
0.6394
0.1137
PHIBOR
0.3599
0.0815
SD
08
-0.3460
-0.4990
21
DATA ANALYSIS Cont’d
Thailand

9
Unit Root Test and Level of Integration:
8
7
All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test.
 5Error Correction Modeling.

6
4
Johanson
3
2
Long Term
Pass-through
Stats
1
0
00
Markup
Granger
Short Term
Degree of
Pass-through
Rate of
Adjustment
Long Term
Markup
Degree of
Pass-through
Short Term
Degree of
Passthrough
Rate 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
0.8650
03
-0.0453
04
1.0659
05
0.4728
06
0.1818
07
-0.0488
08
0.0216
-0.0231
0.0932
-0.0501
FD12
01
0.0557
02
SD
-0.8352
0.1441
-0.0241
1.7463
BLR
-4.5544
BIBOR
0.7609
-0.0492
5.8624
BLR
FD12
-0.1754
FD3
0.3047
FD6
SD
22
DATA ANALYSIS Cont’d
Singapore
6

Unit Root Test and Level of Integration:
5

All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test.
 3Error Correction Modeling.

4
2
Johanson
Long Term
1
Pass-through
Stats
0
FD3
00
Markup
0.4788
01
Short Term
Degree of
Pass-through
02
Granger
0.6899
Rate of
Adjustment
03
Long Term
Markup
-0.0189
0.5652
04
FD6
0.5377
0.8244
-0.0180
0.7645
FD12
0.1514
0.7430
0.9681
SD
0.1746
0.3708
BLR
-5.3294
0.0485
-0.0206
BLR
FD12
-0.0227
FD3
-0.0383
0.3718
5.3200
Short Term
Degree of
Pass-through
05
Degree of
Passthrough
Rate of
Adjustment
0.1153
0.0599
-0.0208
0.1077
0.0587
-0.0198
0.0732
-0.0218
0.0393
-0.0231
0.0423
-0.0349
06
0.1264
FD6
SD
0.0697
SIBOR
0.0538
07
08
23
DATA ANALYSIS Cont’d
Indonesia
24

Unit Root Test and Level of Integration:
20

All interest rate series are Non Stationary and I(1).
16
Cointegration
Tests: Both Johansen’s and Granger’s Test.
12
Error Correction Modeling.
8
Johanson
Long Term
Granger
Short Term
Long Term
Short Term
4
0
Pass-through
Stats
Markup
Degree of
Pass-through
Rate of
Adjustment
Markup
Degree of
Pass-through
FD3
1.0897
1.0436
-0.2866
-0.1158
0.9578
FD6
00
0.4446
01
FD12
-1.1185
0.9231
SD
2.4890
0.7408
BLR
-8.8189
0.5999
1.0026 03
-0.1911 04
1.3105
02
-0.1770
FD12
-0.0562
FD3
-0.1129
FD6
Degree of
Passthrough
050.8469 06
0.1611
Rate of
Adjustment
-0.2832
0.0941 07 -0.187108
3.5308
0.7089
-0.0181
-0.1770
-0.2605
SD
0.5383
0.0402
-0.0569
11.2670
BLR
0.3825
0.0215
JIBOR
-0.1092
24
DATA ANALYSIS Cont’d
Malaysia

Unit Root Test and Level of Integration:
7
6
All interest rate series are Non Stationary and I(1).
Cointegration Tests: Johansen’s Test (10 mth lag).
 Error Correction Modeling.
4

5
Johanson
3
Long Term
2
1
00
Pass-through
Stats
Markup
FD3
Granger
Short Term
Long Term
Short Term
Degree of
Passthrough
Degree of
Pass-through
Rate of
Adjustment
Markup
Degree of
Pass-through
-3.1089
0.0176
-0.0415
3.1311
0.0103
0.2692
-0.0307
FD6
-2.0261
0.3861
03
-0.0454
04
2.6923
0.1705
0.3398
07
-0.0357
08
FD12
-4.9772
0.3661
-0.0418
4.4972
-0.2109
0.3093
-0.0312
SD
-91.0116
BLR
28.8324
0.0007
4.6213FD6-0.8789
0.1204
-0.0024
KLIBOR
4.7960
0.5295
SD
0.3808
-0.0409
01
BLR
02
-3.1920
FD12
1.0484
FD3
-0.0383
05
06
Rate of
Adjustment
25
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.
26
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.
27
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.
28
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
29
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.
30
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.
31