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How Do Banks Set Interest Rates?

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  • Leonardo Gambacorta

    ()
    (Bank of Italy, Economic Research Department)

Abstract

The aim of this paper is to study cross-sectional differences in banks interest rates. It adds to the existing literature in two ways. First, it analyzes systematically the micro and macroeconomic factors that influence the price-setting behaviour of banks. Second, by using banksÂ’ prices (rather than quantities) it provides an alternative way of disentangling loan supply from loan demand shift in the bank lending channel literature. The results, derived from a sample of Italian banks, suggest that heterogeneity in the banking rates pass-through exists only in the short run. Consistently with the literature, interest rates on short-term lending of liquid and well-capitalized banks react less to changes in money market rates. Also banks with a high proportion of long-term lending tend to modify their prices less. Heterogeneity in the pass-through on the interest rate on current accounts depends mainly on banksÂ’ liability structure. Bank size is never relevant.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 542.

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Date of creation: Feb 2005
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Handle: RePEc:bdi:wptemi:td_542_05

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Keywords: monetary policy transmission; interest rates; bank lending channel;

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