Transmission of Monetary Policy Impulses on Bank Retail Interest Rates: An Empirical Study of Sri Lanka

Abstract

The study examines the transmission of monetary policy impulses to bank retail interest rates in Sri Lanka. Understanding the interest rate pass-through process, from policy rates to bank retail rates are imperative to conduct monetary policy operations successfully. The variables used in this study are central bank policy interest rates that are repo and reverse repo rates, overnight interbank call money market rates, and various types of commercial bank lending and deposit rates. Among other econometric techniques, the Error Correction Mechanism is used in the present study as a main technique to analyse the interest rate pass through mechanism empirically. The data is for the 10-year period from 2003 to 2013. The key conclusion is, in general, that there is no one for one interest rate pass-through to the long-run commercial bank rates from money market rate. Nevertheless, there is a sizable and satisfactory pass-through in the long-run in fixed deposit rates. In contrast, the long-run pass-through is not satisfactory with regard to retail loan interest rates. In the short-run, bank retail rates deviated from the equilibrium due to monetary policy shocks, but were adjusted to their equilibrium levels in the long-run. Also it was found that, on average, short-run adjustment speed of deposit rates is less compared with the lending rates. Further, the short-run adjustment speed is higher for shorter maturities. In general, there is no asymmetry in interest rate pass-through in Sri Lanka.