How do UK Banks React to Changing Central Bank Rates?

34 Pages Posted: 28 May 2008

See all articles by Ana-Maria Fuertes

Ana-Maria Fuertes

Cass Business School, City University of London

Shelagh Heffernan

City University London - Sir John Cass Business School

Elena Kalotychou

Cass Business School, City, University of London

Date Written: May 1, 2008

Abstract

This paper explores the interest rate transmission mechanism using a broad disaggregated sample of UK deposit and credit products. For a large proportion of rates the adjustment speed is time-varying, switching among four regimes according to the direction of the policy rate and its effect on the disequilibrium gap. In general, this sign asymmetry implies faster adjustment to the long run path when the policy rate revision widens the gap. There is evidence of curvature in the catch-up effect towards equilibrium, namely, large gaps entail a disproportionately faster correction although mainly for deposits. The size of the policy rate change also impacts the adjustment speed. The notable heterogeneity found across financial institutions/products regarding the presence of these nonlinear patterns raises important questions on how to assess the effectiveness of monetary policy. The cross-section heterogeneity uncovered can be explained to some extent by diversification, profit volatility, product range, market concentration and menu costs.

Keywords: Error Correction Model, Adjustment Speed, Time-variation, Regime-Switching, Curvature

JEL Classification: G20, G21, E43, E52

Suggested Citation

Fuertes, Ana-Maria and Heffernan, Shelagh A. and Kalotychou, Elena, How do UK Banks React to Changing Central Bank Rates? (May 1, 2008). Cass Business School Research Paper No. 03-08, Available at SSRN: https://ssrn.com/abstract=1138325 or http://dx.doi.org/10.2139/ssrn.1138325

Ana-Maria Fuertes (Contact Author)

Cass Business School, City University of London ( email )

Faculty of Finance
106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 207 477 0186 (Phone)
+44 207 477 8881 (Fax)

HOME PAGE: http://www.city.ac.uk/people/academics/ana-maria-fuertes

Shelagh A. Heffernan

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Elena Kalotychou

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
Great Britain

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