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How do banks' funding costs affect interest margins?

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  • Arvid Raknerud
  • Bjørn Helge Vatne
  • Ketil Rakkestad

    ()
    (Statistics Norway)

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    Abstract

    We use a dynamic factor model and a detailed panel data set with quarterly accounts data on all Norwegian banks to study the effects of banks' funding costs on their retail rates. Banks' funds are categorized into two groups: customer deposits and long-term wholesale funding (market funding from private and institutional investors including other banks). The cost of market funding is represented in the model by the three-month Norwegian Inter Bank Offered Rate (NIBOR) and the spread of unsecured senior bonds issued by Norwegian banks. Our estimates show clear evidence of incomplete pass-through: a unit increase in NIBOR leads to an approximately 0.8 increase in bank rates. On the other hand, the difference between banks' loan and deposit rates is independent of NIBOR. Our findings are consistent with the view that banks face a downward-sloping demand curve for loans and an upward-sloping supply curve for customer deposits.

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    Bibliographic Info

    Paper provided by Research Department of Statistics Norway in its series Discussion Papers with number 665.

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    Date of creation: Sep 2011
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    Handle: RePEc:ssb:dispap:665

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    Keywords: interest rates; NIBOR; pass-through; funding costs; bank panel data; dynamic factor model;

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    1. Pesaran, M.H. & Smith, R., 1992. "Estimating Long-Run Relationships From Dynamic Heterogeneous Panels," Cambridge Working Papers in Economics 9215, Faculty of Economics, University of Cambridge.
    2. Maudos, Joaquin & Fernandez de Guevara, Juan, 2003. "Factors Explaining the Interest Margin in the Banking Sectors of the European Union," MPRA Paper 15252, University Library of Munich, Germany.
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