Banks’ Interest Rate Setting and Transitions between Liquidity Surplus and Deficit

18 Pages Posted: 12 Aug 2021 Last revised: 21 Sep 2021

Date Written: August 10, 2021

Abstract

Assuming that a central bank is successful in steering money market interest rates, commercial banks’ loan rate setting behaviour is not expected to change during a transition between liquidity surplus and deficit. However, this logic does not hold if the interest rates for the lending and borrowing activities of an individual bank on the money market do not coincide. In this environment, it may be appropriate to adjust the loan rates when a bank transitions between liquidity surplus and deficit (i.e. switches between the benchmark money market rates). This strategy is fundamentally different from linking the loan rates to the average cost of funding (i.e. the average between retail and wholesale funding rates). The magnitude of such loan rate adjustment is limited by the (usually moderate) spread between the funding and investment money market rates.

Keywords: Excess reserves, Lending rates, Fund transfer pricing, Russia.

JEL Classification: E43, E51, E58, G21, C63.

Suggested Citation

Grishina, Tatiana and Ponomarenko, Alexey, Banks’ Interest Rate Setting and Transitions between Liquidity Surplus and Deficit (August 10, 2021). Available at SSRN: https://ssrn.com/abstract=3902640 or http://dx.doi.org/10.2139/ssrn.3902640

Tatiana Grishina

Bank of Russia ( email )

12 Neglinnaya Street
Moscow, 107016
Russia

Alexey Ponomarenko (Contact Author)

Bank of Russia ( email )

12 Neglinnaya Street
Moscow, 107016
Russia

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