Interest rate pass-through and banking market Integration in ASEAN: A Cross Country Comparison

Abstract

Inflation targeting has been the main policy objective for most of the central banks around the world and the interest rate transmission has attracted much more attention than ever before. Understanding of interest rate channel is crucial to uncover monetary policy transmission mechanism. This study deals with the interest rate pass-through, which is defined as the degree and the speed of adjustment of retail bank rates to monetary policy interest rate, in selected ASEAN Countries (Malaysia, Indonesia, Singapore, Philippines and Thailand). The effectiveness of interest rate channel in economy is quantified by analyzing the pass-through of interest rate from policy rate to retail banking rate. Short term money market rate has been used as a proxy for the policy rate and various deposit and loan rates of different maturities have been used for analysis. Unit root, cointegration and Error correction Modeling has been applied on the data set to find the short-run and long-run relationship between the interest rates. It has been found that there is great amount of heterogeneity in the pass-through among various loan and deposit categories. This difference is found both in terms of degree and speed of adjustment. Indonesia and Philippines have the most effective interest rate transmission mechanism, followed by Thailand, Singapore and Malaysia. The low level of pass-through for Malaysia and Singapore can be attributed to the high level of regulations in banking sector, high banking sector competition and high switching costs. Research indicates a very low level of banking market integration for ASEAN.