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Bank Asset Quality & Monetary Policy Pass-Through

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  • Byrne, David

    (Central Bank of Ireland)

  • Kelly, Robert

    (Central Bank of Ireland)

Abstract

The funding mix of European firms is heavily weighted towards bank credit, underscoring the importance of efficient pass-through of monetary policy actions to lending rates faced by firms. Euro area pass-through has shifted from being relatively homogenous to fragmented and incomplete since the financial crisis. Distressed loan books are a crisis hangover with direct implications for profitability, hampering banks ability to supply credit and lower loan pricing in response to reductions in the policy rate. This paper presents a parsimonious model to decompose the cost of lending and highlight the role of asset quality in diminishing pass-through. Using bank level data over the period 2008-2014, we empirically test the implications of the model, with results showing that asset quality, measured through a one percentage point increase in the impairment ratio have a significant negative impact, lowering immediate pass-through by 3 per cent. For impairment rates greater than 17 per cent, we find that pass-though is not significantly different from zero. We derive a measure of the hidden bad loan problem, the NPL gap, which we define as the excess of NPLs over impaired loans. We show it played a significant role in the fragmentation of euro area pass-through post-crisis.

Suggested Citation

  • Byrne, David & Kelly, Robert, 2017. "Bank Asset Quality & Monetary Policy Pass-Through," Research Technical Papers 11/RT/17, Central Bank of Ireland.
  • Handle: RePEc:cbi:wpaper:11/rt/17
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    Cited by:

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    2. Raftis, Achilleas & Karpetis, Christos & Papadamou, Stephanos & Spyromitros, Eleftherios, 2024. "Monetary winds of change: Exploring the link between policy shifts and bank profitability in developed and emerging European markets," Global Finance Journal, Elsevier, vol. 59(C).
    3. Saibal Ghosh, 2022. "Does financial interconnectedness affect monetary transmission? Evidence from India," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 15(3), pages 273-300, September.
    4. Fernando, Antonette, 2022. "The Role of Financial Structural Factors in Retail Rate Adjustment: Evidence from Sri Lanka," OSF Preprints gn5jp, Center for Open Science.
    5. Jugnu Ansari & Saibal Ghosh, 2021. "Monetary Policy Pass-through, Ownership and Crisis: How Robust is the Indian Evidence?," Margin: The Journal of Applied Economic Research, National Council of Applied Economic Research, vol. 15(4), pages 456-483, November.
    6. Byrne, David & Foster, Sorcha, 2023. "Transmission of monetary policy: Bank interest rate pass-through in Ireland and the euro area," Economic Letters 3/EL/23, Central Bank of Ireland.
    7. Morell, Joe & Shaw, Frances & Lyons, Paul & McCann, Fergal, 2022. "Rising interest rates and higher inflation: implications for the banking sector," Financial Stability Notes 15/FS/22, Central Bank of Ireland.

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    More about this item

    Keywords

    Monetary Policy Pass-through; Impaired Loans; Non-Performing Loans; Interest Rates;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • 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
    • 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

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