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Banks’ interest rate setting and transitions between liquidity surplus and deficit

Author

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  • Tatiana Grishina

    (Bank of Russia)

  • Alexey Ponomarenko

    (Bank of Russia)

Abstract

Assuming that a central bank is successful in steering money market interest rates, commercial banks’ loan rate setting behavior is not expected to change during a transition between liquidity surplus and deficit. We illustrate this point by running a microsimulation exercise. We show that banks that do not adjust lending rates in response to deposits’ outflow outperform banks that link lending rates to average costs of funding. Therefore, central banks that face fluctuations in autonomous liquidity factors should not expect an inevitable changes in lending rates should not necessarily preemptively adjust monetary policy stance in an attempt to compensate for changes in lending rates. However, this logic does not hold if the interest rates for the lending and borrowing activities of an individual bank on the money market do not coincide. We show that in the fragmented money markets environment, it may be appropriate to adjust the loan rates when a bank transitions between liquidity surplus and deficit (i.e., switches between the benchmark money market rates). The magnitude of such loan rate adjustment is limited by the (usually moderate) spread between the funding and investment money market rates.

Suggested Citation

  • Tatiana Grishina & Alexey Ponomarenko, 2023. "Banks’ interest rate setting and transitions between liquidity surplus and deficit," SN Business & Economics, Springer, vol. 3(12), pages 1-18, December.
    • Handle: RePEc:spr:snbeco:v:3:y:2023:i:12:d:10.1007_s43546-023-00595-1
    DOI: 10.1007/s43546-023-00595-1
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    More about this item

    Keywords

    Excess reserves; Lending rates; Fund transfer pricing; Russia;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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