Interest Rate Pass-Through And Determinants Of Commercial Banks’ Loan Pricing Decisions In India: Empirical Evidence From Dynamic Panel Data Model

Commercial banks’ loan pricing decisions can be useful for policy purposes from the perspectives of effective financial intermediation, stability of financial system, economic stability and monetary transmission mechanism. Taking cues from the large literature and using the dynamic panel data methodology and annual data for a sample of 33 banks including public, private and foreign banks over the period 1996-2011, this study provides an empirical reflection on the interest rate channel pass-through and the impact of various bank specific factors, regulatory and supervisory indicators and macroeconomic factors on Indian banks’ loan pricing decisions. The empirical analysis brings to the fore some useful applied perspectives and key insights for policy purposes. Firstly, proximate determinants can have differential effects on banks’ loan pricing decisions depending upon alternative measures of loan interest rate and spreads. This is a critical finding as it will provide insights to future empirical studies. Secondly, the pass-through from the policy rate to loan interest rates could be limited when commercial banks consider several factors including the policy rate for their loan pricing decisions. Moreover, the problem of pass-through evident from differential impacts of interbank money market rate and the repo rate could relate to the alignment between liquidity and interest rate channels of transmission mechanism. Thirdly, banks’ operating efficiency holds the key to softer margins and effective loan pricing decisions in the Indian context. Fourthly, higher capital charge can induce risk aversion and positively affect loan interest rate. Fifthly, the absence of clear statistically significant and positive impact of the asset quality variable, i.e., non-performing loans, suggests that there is a need for strengthening risk pricing culture in the Indian context. Finally, bank size variable, which is often considered for gauging economies of scale effect, does not hold for the Indian context. It is expected that the empirical findings of the paper could be useful for reform and policy purposes.