How Do Banks Set Interest Rates?

39 Pages Posted: 16 Feb 2004 Last revised: 20 Aug 2010

See all articles by Leonardo Gambacorta

Leonardo Gambacorta

Bank for International Settlements (BIS); Centre for Economic Policy Research (CEPR)

Date Written: February 2004


The aim of this paper is to study cross-sectional differences in banks interest rates. It adds to the existing literature in two ways. First, it analyzes in a systematic way both micro and macroeconomic factors that influence the price setting behavior of banks. Second, by using banks' prices (rather than quantities) it provides an alternative way to disentangle loan supply from loan demand shift in the bank lending channel' literature. The results, derived from a sample of Italian banks, suggest that heterogeneity in the banking rates pass-through exists only in the short run. Consistently with the literature for Italy, interest rates on shortterm lending of liquid and well-capitalized banks react less to a monetary policy shock. Also banks with a high proportion of long-term lending tend to change their prices less. Heterogeneity in the pass-through on the interest rate on current accounts depends mainly on banks' liability structure. Bank's size is never relevant.

Suggested Citation

Gambacorta, Leonardo, How Do Banks Set Interest Rates? (February 2004). NBER Working Paper No. w10295, Available at SSRN:

Leonardo Gambacorta (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002

Centre for Economic Policy Research (CEPR)

United Kingdom

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