Imperfect Competition in Bank Retail Markets, Deposit and Loan Rate Dynamics, and Incomplete Pass Through

Abstract

This paper examines determinants of pass through from the market interest rate to bank retail deposit and loan rates. A dynamic adjustment cost model with imperfect competition implies that these rates depend on own lagged values and on lagged, current, and expected future values of the security rate. Greater competition in retail markets reduces the impact of lagged and expected rates on current retail rates while raising the effect of the current security rate, yielding greater pass through. These results have important implications for both the specifications used in empirical work and biases introduced into estimates of pass‐through effects.

The Industrial Organization of Banking

“…There are certainly theoretical grounds for the idea that the magnitude of passthrough effects should depend on the degree of competition in banking markets, as shown by Kopecky and VanHoose (2009). This study combines a linearized version of VanHoose's (1985) oligopoly model of bank loan and deposit markets with Elyasiani et al's (1995) model of fundamental dynamics discussed in the previous chapter.…”

Global banking and the conduct of macroprudential policy in a monetary union

“…in Van Leuvensteijn et al (2013) through imperfect competition among banking systems, while Kopecky and Van Hoose (2012) rely on intertemporal quantity adjustment costs together with imperfect competition to explain such observations. The adoption of a Calvo mechanism combined with monopolistic competition has been employed here in a macro-perspective for credit and deposit interest rates, as this solution allows us to consider the sluggishness in the adjustment of all the nominal variables of the economy (prices, wages and interest rates) through the estimation of a "Calvo lottery parameter".…”

“…In particular, sluggish and even asymmetric variations in bank retail rates have been documented in the empirical literature as in Kopecky and Van Hoose (2012) and Van Leuvensteijn et al (2013) through imperfect competition among banking systems. The setting of interest rate mimics the way other sticky nominal variables such as prices and wages are set in the model.…”

How Do Anticipated Changes to Short‐Term Market Rates Influence Banks' Retail Interest Rates? Evidence from the Four Major Euro Area Economies

“…Elyasiani, Kopecky, and Van Hoose () and Kopecky and Van Hoose () have a similar model in which they maximize bank profits, which are adjusted to allow for quadratic adjustment costs. Their model depends on the interest rates on loans, deposits, and the money market (securities), and the quantities of deposits and loans received by the banks.…”