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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 banks� 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 banks� liability structure. Bank size is never relevant.

Suggested Citation

  • Leonardo Gambacorta, 2005. "How Do Banks Set Interest Rates?," Temi di discussione (Economic working papers) 542, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_542_05
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    References listed on IDEAS

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    More about this item

    Keywords

    monetary policy transmission; interest rates; bank lending channel;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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