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Journal of Financial Services Research

Erschienen in:

01.06.2010

How do UK Banks React to Changing Central Bank Rates?

verfasst von: Ana-Maria Fuertes, Shelagh Heffernan, Elena Kalotychou

Erschienen in: Journal of Financial Services Research | Ausgabe 2-3/2010

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Abstract

This paper explores the interest rate transmission mechanism using a broad disaggregated sample of UK deposit and credit products. For a large proportion of rates the adjustment speed is time-varying, switching among four regimes according to the direction of the policy rate and its effect on the disequilibrium gap. In general, this sign asymmetry implies faster adjustment to the long run path when the policy rate revision widens the gap. There is evidence of curvature in the catch-up effect towards equilibrium, namely, large gaps entail a disproportionately faster correction although mainly for deposits. The size of the policy rate change also impacts the adjustment speed. The notable heterogeneity found across financial institutions/products regarding the presence of these nonlinear patterns raises important questions on how to assess the effectiveness of monetary policy. The cross-section heterogeneity uncovered can be explained to some extent by diversification, profit volatility, product range, market concentration and menu costs.

Vorheriger Artikel Liquidity, Bank Runs, and Bailouts: Spillover Effects During the Northern Rock Episode

Nächster Artikel Market Structure, Capital Regulation and Bank Risk Taking

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See Sheshinski and Weiss (1977), Rotemberg (1982), Calvo (1983) and Klemperer (1987), inter alios.

A few studies such as Hannan and Berger (1991), Neumark and Sharpe (1992), and Mester and Saunders (1995) have used other approaches (e.g. logit models) to investigate retail rate behaviour.

The data sources are Moneyfacts and Business Moneyfacts, two monthly publications of the Moneyfacts Group (www.moneyfacts.co.uk). The deposit tiers are chosen by the Moneyfacts Group and do not change over the sample period. Banks report the deposit rate they pay at each tier.

According to Miles (2003), 90% of mortgage lending in the UK is either variable rate or fixed for a term of up to 2 years, and 66% of all mortgages are variable rate. The interest rate volatility of the early 1990s prompted the growth of fixed rate mortgages but they continue to have a very small market share.

The interest rate quoted for deposits is the gross annual equivalent rate or AER (compounded interest) with no tax deducted. For credit products, it is the annual percentage rate (APR) which includes the compounded interest paid on loans, outstanding store and credit card balances. All rates are variable.

Every month since May 1997, the BoE’s Monetary Policy Committee has been revising the policy rate in order to achieve inflation targets. The name given to this rate has changed through the years (e.g. base rate, minimum lending rate, repo rate). Since July 2006, it has been called the official bank rate paid on commercial bank reserves, the name used before 1972. In this study, it is also called policy rate because the markets interpret an increase/decrease in it as a tightening/loosening of monetary policy.

A similar phenomenon was observed in 1998 with the collapse of the hedge fund Long Term Capital Markets but it was confined largely to the US and quickly resolved.

www.bankofengland.co.uk/statistics.

At the time of estimation, the Top 5 were HSBC, Royal Bank of Scotland, HBOS, Barclays and Lloyds TSB. Lloyds is much smaller than the others in the group, if measured by assets or tier 1 capital, but very active in the retail sector.

The underlying theoretical foundations for these arguments are found in, respectively, Sheshinski and Weiss (1977), Klemperer (1987) and Stiglitz and Weiss (1981, 1983).

Time variation in the adjustment speed, as portrayed in (2), is not a nonlinearity per se. However, it can be cast as such in the sense that it represents a departure from the conventional linear ECM.

A quadratic term is excluded in Eq. 4 because it is not in the spirit of an error correction mechanism or catch-up effect which, by definition, ought to be reducing the retail rate x _t when the gap is positive and raising it when the gap is negative. This is because, for a given adjustment coefficient, the second-order error correction term γu ² _t−1 is sign invariant whereas the signs of the first-order γu _t−1 and third-order γu ³ _t−1 counterparts depend on u _t−1.

The lag orders p and q are chosen so as to absorb all the residual autocorrelation. The interest rate series have non-stationary I(1) properties. A battery of tests in Fuertes and Heffernan (2009) confirm the existence of long run co-movement between each retail rate and the BoE policy rate.

The cross-section average of the gap remains at around 0.25% for the rest of the sample period.

From January 1999 to May 2004 the official rate fell by 2%, with the exception of 12 months from January 2000, when it rose by approximately 50 basis points.

Made by representative Goldborough to Governor Eccles (latter Chairman of the Fed) on 4 March, 1935 during the hearing into the Banking Act. The statement is recently recalled by Orphanides (2006).

See also Bernanke and Gertler (1995, 2001).

Sources: Bank of England (2008) and Office for National Statistics (2008).

In some publications, store cards appear as subsets of unsecured loans.

The correlation between bank size and number of bank branches is high at 65%.

As noted in Table 4, the ratio of overhead expenses to assets has the practical advantage of being available for more FIs (66) as compared to the ratio of branches to assets (23).

The cross-section analysis is based on the 66 FIs (out of a possible 113) for which data are available on all the independent variables. The correlation between ROAA and ROAE is high at 73% and both are highly correlated with other variables. For this reason, we only focus on the variance of the ROAE growth rate (VROAE) and its average fall (FROAE) over the period. The correlation between asset value (SIZE) and market share (MS) is high at 98%, and likewise for overhead costs (OH) and diversification (DIV) at 80%. To avoid multicollinearity, these variables are entered in separate regressions.

Bank of England (2005) Bank of England quarterly model, London: Bank of England, http://www.bankofengland.co.uk/publications/other/beqm/beqmfull.pdf.

Bank of England (2008) Interactive Statistical Database (code LPMVZRD), http://www.bankofengland.co.uk/mfsd/iadb/NewIntermed.asp

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Titel: How do UK Banks React to Changing Central Bank Rates?
verfasst von: Ana-Maria Fuertes
Shelagh Heffernan
Elena Kalotychou
Publikationsdatum: 01.06.2010
Verlag: Springer US
Erschienen in: Journal of Financial Services Research / Ausgabe 2-3/2010
Print ISSN: 0920-8550
Elektronische ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-009-0056-9

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