Bank Interest Rate Setting in the Euro Area During the Great Recession

36 Pages Posted: 20 Sep 2016

See all articles by Gonzalo Camba-Mendez

Gonzalo Camba-Mendez

European Central Bank (ECB)

Alain Durré

European Central Bank (ECB) - Directorate General Economics; IéSEG - Université Catholique de Lille; National Center for Scientific Research - LEM

Francesco Paolo Mongelli

European Central Bank (ECB); Goethe University Frankfurt

Date Written: September 19, 2016

Abstract

This paper sheds light on how recent financial tensions in the euro area were ultimately reflected in bank interest rate setting. We make two new contributions. First, we develop a theoretical model capturing banks financing and the rate setting choices. Banks in the model can finance themselves through deposits, on the money market and/or by issuing bonds. Second, we assemble a novel database and put our model to test. Our model extends that of Gambacorta (2004), as we formalise banks' decision to issue debt endogenously. Gambacorta's analysis was conducted for Italian banks and did not include the recent financial crisis. Instead, we focus our analysis on the Great Recession period (July 2007 to October 2014) and euro area banks. From a monetary policy perspective, both our theoretical model and the empirical results provide useful information on the impact of some of the measures introduced by the ECB during the financial crisis. First, the ECB introduced specific measures to alleviate tensions in money markets. To the extent that these measures fostered stability in money markets, and reduced the volatility of money market rates, this paper shows that they were also channelled to bank rates. Second, the ECB also introduced measures to address tensions in bond markets. Our results also show that having access to debt financing has important implications for bank rate setting.

Keywords: bank interest rate setting, bank financing, non-standard monetary policy and euro area crisis

JEL Classification: C32, E43, E52, E58, G01

Suggested Citation

Camba-Mendez, Gonzalo and Durre, Alain C. J. and Mongelli, Francesco Paolo, Bank Interest Rate Setting in the Euro Area During the Great Recession (September 19, 2016). ECB Working Paper No. 1965, Available at SSRN: https://ssrn.com/abstract=2840641

Gonzalo Camba-Mendez (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Alain C. J. Durre

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

IéSEG - Université Catholique de Lille ( email )

3, rue de la Digue
F-59800 Lille
France

National Center for Scientific Research - LEM ( email )

106-112 Boulevard de l'Hopital
F- 75647 Paris Cedex 13
France

Francesco Paolo Mongelli

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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