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Bank Asset Quality & Monetary Policy Pass-Through

David Byrne and Robert Kelly

No 11/RT/17, Research Technical Papers from Central Bank of Ireland

Abstract: The funding mix of European firms is heavily weighted towards bank credit, underscoring the importance of efficient pass-through of monetary policy actions to lending rates faced by firms. Euro area pass-through has shifted from being relatively homogenous to fragmented and incomplete since the financial crisis. Distressed loan books are a crisis hangover with direct implications for profitability, hampering banks ability to supply credit and lower loan pricing in response to reductions in the policy rate. This paper presents a parsimonious model to decompose the cost of lending and highlight the role of asset quality in diminishing pass-through. Using bank level data over the period 2008-2014, we empirically test the implications of the model, with results showing that asset quality, measured through a one percentage point increase in the impairment ratio have a significant negative impact, lowering immediate pass-through by 3 per cent. For impairment rates greater than 17 per cent, we find that pass-though is not significantly different from zero. We derive a measure of the hidden bad loan problem, the NPL gap, which we define as the excess of NPLs over impaired loans. We show it played a significant role in the fragmentation of euro area pass-through post-crisis.

Keywords: Monetary Policy Pass-through; Impaired Loans; Non-Performing Loans; Interest Rates (search for similar items in EconPapers)
JEL-codes: D43 E51 E52 E58 G21 (search for similar items in EconPapers)
Date: 2017-12
New Economics Papers: this item is included in nep-ban, nep-eec, nep-mac and nep-mon
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