Banking competition and interest rate pass-through

The interest rate pass-through (PT) from the central bank’s main policy interest rate to bank lending and deposit interest rates is central to monetary policy transmission. However, in many countries the effectiveness of the monetary policy is limited by a slow, incomplete, and asymmetric PT. Within a currency union, the effectiveness of a common monetary policy is furthermore restricted by the cross-country heterogeneity of the PT. Differences in banking competition are an important though not necessarily a sole source of this heterogeneity. This chapter provides a review of the empirical PT literature and pays specific attention to the effects of banking market competition. While the evidence for a positive impact of competition on the PT is overwhelming, empirical studies differ in terms of pass-through methodology and measurement of competition, and a best-practice approach has yet to emerge. The authors consequently propose a broad-based rather than a single competition measure: the use of (combinations of) various competition indicators, such as market shares, price elasticity of demand, and conjectural variation; and the investigation of the impact of different, complementary sources of competition from banks, non-banks, markets, and foreign competition.