Pass-through of Change in Policy Interest Rate to Market Rates

Abstract

This paper examines the pass through of the change in policy interest rate of the central bank of Pakistan to market interest rates. The market rates examined include KIBOR, six month deposit rate and weighted average lending rate. More or less complete pass-through of the change in policy rate to KIBOR is observed within one month. However, the magnitude of change in policy rate to deposit and lending rate is not only low but is slow as well. The pass-through to the weighted average lending rate is 47 percent and occurs with a lag of one to one and half year. The pass-through to the deposit rate is only 16 percent and occurs with a lag of one year. The asymmetry between the magnitude of pass-through to lending and deposit rates has served to increase the interest margin of the banks. The slow pass-through to the lending and deposit rate put limits on the effectiveness of interest rate as a policy tool. The pass-through, and hence the effectiveness of monetary policy will increase if all the lending and deposit rates are floating in nature and are quoted as KIBOR-plus and KIBOR-minus respectively.