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The Effects Of Open Market Interest Rates On Malaysian Commercial Banks’ Interest Rate Spread: An Empirical Analysis

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  • Noor Azlan Ghazali and Khairul Anuar Mohd. Ali

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    Abstract

    In this paper we investigate the effect of changes in open market interest rates on the interest rate spread of Malaysian commercial banks. This is performed by examining the causality and patterns of reactions of banking rates with respect to variation in open market rates. Based on vector autoregression analysis we show that there is one-way causation running from the open market rates to banking rates. Changes in open market rates significantly cause changes in the spread and deposit rates. However, no significant causation is identified for lending rates. The impulse response functions indicate that spread declines following positive innovation in open market rates and this is mainly due to the greater sensitivity of deposit rates to open market rates. The response of lending rates is shown to be low and to occur with some lag, thus, contributing to the decline in spread. We also provide evidence of a dichotomy between banks’ asset and liability rates by failing to support causality between the two rates. It is argued that this imbalance of sensitivity is partly due to the uneven process of interest rate liberalization that frees deposit rates more than lending rates. These results suggest that for the Malaysian banking firms, increase in open market rates hindered their activities and could affect bank performance. The findings are consistent with the role of banks as brokers as well as asset transformers.

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    Bibliographic Info

    Article provided by IIUM Journal of Economis and Management in its journal IIUM Journal of Economics and Management.

    Volume (Year): 10 (2002)
    Issue (Month): 1 (June)
    Pages: 21-42

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    Handle: RePEc:ije:journl:v:10:y:2002:i:1:p:21-42

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    Related research

    Keywords: Interest rate spread; Bank profitability; Vector autoregression;

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    1. Hayne E. Leland and David H. Pyle., 1976. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Research Program in Finance Working Papers 41, University of California at Berkeley.
    2. Fama, Eugene F., 1980. "Banking in the theory of finance," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 39-57, January.
    3. Baltensperger, Ernst, 1980. "Alternative approaches to the theory of the banking firm," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 1-37, January.
    4. Pyle, David H, 1971. "On the Theory of Financial Intermediation," Journal of Finance, American Finance Association, vol. 26(3), pages 737-47, June.
    5. Bae, Sung C, 1990. "Interest Rate Changes and Common Stock Returns of Financial Institutions: Revisited," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 13(1), pages 71-79, Spring.
    6. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July.
    7. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October.
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