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Loan Rate Stickiness: Theory and Evidence

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Author Info
Philip Lowe (Reserve Bank of Australia)
Thomas Rohling (Reserve Bank of Australia)
Abstract

Financial deregulation in the 1980s saw the lifting of regulations on interest rates charged by banks. In general, lending rates now respond more quickly to changes in banks' cost of funds than they did in the regulated period. However, lending rates still do not always move one for one with changes in banks' marginal cost of raising funds. This paper canvasses four theoretical explanations, other than collusive behaviour, for loan rate stickiness. These theories are based on equilibrium credit rationing, switching costs, implicit risk sharing and consumer irrationality. Using regression analysis, we also examine the degree of stickiness of Australian interest rates on secured and unsecured personal loans, credit cards, small and large business overdrafts, and housing loans. We find significant differences in the degree of interest rate stickiness among the different rates, even after allowing for lags in adjustment. The rate on credit cards is found to be the most sticky, followed by personal loan rates, the housing loan rate and the small business overdraft rate. The large business overdraft rate is found to adjust one for one with banks' marginal cost of funds. We briefly examine the behaviour of selected U.S., U.K. and Canadian interest rates. The general order and magnitude of interest rate stickiness is similar to that found for Australia. Although it is not possible to empirically discriminate between the different theories of loan rate sticluness, we interpret the results as providing strong evidence for the switching cost explanation. In addition, implicit risk sharing probably plays an important role in the stickiness of the housing loan rate.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9206.

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Date of creation: Jun 1992
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Handle: RePEc:rba:rbardp:rdp9206

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References listed on IDEAS
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    Other versions:
  2. Gertler, Mark, 1988. "Financial Structure and Aggregate Economic Activity: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(3), pages 559-88, August. [Downloadable!] (restricted)
    Other versions:
  3. Fried, Joel & Howitt, Peter, 1980. "Credit Rationing and Implicit Contract Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 471-87, August. [Downloadable!] (restricted)
  4. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
  5. Jerome Fahrer & Thomas Rohling, 1992. "Some Tests of Competition in the Australian Housing Loan Market," RBA Research Discussion Papers rdp9202, Reserve Bank of Australia. [Downloadable!]
  6. Allen N. Berger & Gregory F. Udell, 1990. "Some evidence on the empirical significance of credit rationing," Finance and Economics Discussion Series 105, Board of Governors of the Federal Reserve System (U.S.).
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  7. Azariadis, Costas, 1976. "On the Incidence of Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 43(1), pages 115-25, February. [Downloadable!] (restricted)
  8. Williamson, Stephen D, 1987. "Costly Monitoring, Loan Contracts, and Equilibrium Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 135-45, February. [Downloadable!] (restricted)
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  9. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August. [Downloadable!] (restricted)
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  14. Timothy H. Hannan & J. Nellie Liang, 1991. "Inferring market power from time-series data: the case of the banking firm," Finance and Economics Discussion Series 147, Board of Governors of the Federal Reserve System (U.S.).
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  15. Paul S. Calem, 1992. "The strange behavior of the credit card market," Business Review, Federal Reserve Bank of Philadelphia, issue Jan, pages 3-14.
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  1. Chmielewski, Tomasz, 2003. "Interest rate pass-through in the Polish banking sector and bank-specific financial disturbances," MPRA Paper 5133, University Library of Munich, Germany, revised 31 Jan 2004. [Downloadable!]
  2. Carolyn Currie, 2003. "Towards a General Theory of Financial Regulation: Predicting, Measuring and Preventing Financial Crises," Working Paper Series 132, School of Finance and Economics, University of Technology, Sydney. [Downloadable!]
    Other versions:
  3. Linda A. Toolsema & Jan-Egbert Sturm & Jakob de Haan, 2001. "Convergence of Monetary Transmission in EMU New Evidence," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  4. Gabe de Bondt, 2002. "Retail bank interest rate pass-through: new evidence at the Euro area level," Working Paper Series 136, European Central Bank. [Downloadable!]
  5. Marianne Gizycki & Mark Levonian, 1993. "A Decade of Australian Banking Risk: Evidence from Share Prices," RBA Research Discussion Papers rdp9302, Reserve Bank of Australia. [Downloadable!]
  6. Philip Lowe & Thomas Rohling, 1993. "Agency Costs, Balance Sheets and the Business Cycle," RBA Research Discussion Papers rdp9311, Reserve Bank of Australia. [Downloadable!]
  7. Philip Lowe, 1995. "The Link Between the Cash Rate and Market Interest Rates," RBA Research Discussion Papers rdp9504, Reserve Bank of Australia. [Downloadable!]
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