How Do Banks Set Interest Rates

Working Paper: NBER ID: w10295

Authors: Leonardo Gambacorta

Abstract: The aim of this paper is to study cross-sectional differences in banks interest rates. It adds to the existing literature in two ways. First, it analyzes in a systematic way both micro and macroeconomic factors that influence the price setting behavior of banks. Second, by using banks' prices (rather than quantities) it provides an alternative way to disentangle loan supply from loan demand shift in the bank lending channel' literature. The results, derived from a sample of Italian banks, suggest that heterogeneity in the banking rates pass-through exists only in the short run. Consistently with the literature for Italy, interest rates on shortterm lending of liquid and well-capitalized banks react less to a monetary policy shock. Also banks with a high proportion of long-term lending tend to change their prices less. Heterogeneity in the pass-through on the interest rate on current accounts depends mainly on banks' liability structure. Bank's size is never relevant.

Keywords: No keywords provided

JEL Codes: E44; E51; E52

Causal Claims

Cause	Effect
Heterogeneity in the banking rates passthrough (G21)	Banks' price-setting behavior is sensitive to immediate monetary policy shocks (E44)
Interest rates on short-term lending of liquid and well-capitalized banks (G21)	Bank liquidity and capitalization mediate the effects of monetary policy on interest rates (E52)
Banks with a high proportion of long-term lending (G21)	Their pricing behavior is influenced by the stability of their funding sources (L11)
Heterogeneity in the passthrough of interest rates on current accounts (E49)	Banks with different funding structures experience varying degrees of sensitivity to market interest rate changes (G21)
Size does not play a significant role in determining the responsiveness of banks to monetary policy (E58)	Contrasts with findings from other studies (C90)