CFCM 15/05: Why Did Bank Lending Rates Diverge from Policy Rates After the Financial Crisis

Summary

The global financial crisis prompted central banks in many countries to cut short-term policy rates to near zero levels after the Lehman collapse in September 2008. Based on the pre-crisis relationship between policy rates and bank lending rates on household mortgages or loans to businesses, it would have been reasonable to expect lending rates to have fallen by similar amounts. But examination of the lending rates reveals they did not fall that much. In some countries this has prompted an outcry that banks were taking advantage low borrowing costs to profit from their customers by keeping lending rates higher than they needed to be. 

This turned out not to be true. In this Nottingham School of Economics working paper Paul Mizen and co-authors present evidence from 11 European countries that the underlying cost of funding (based on a new weighted average cost of liabilities measure reflecting the actual funding costs of banks) has not fallen as much as policy rates, in fact in some countries it has risen with greater perceived credit risks associated particularly with the European sovereign debt crisis. It explains why banks have not lowered their lending rates in line with policy rates. It also answers another puzzle for central banks – has the relationship between lending rates and funding broken down since the crisis? The paper shows that the relationship between the actual cost of funding and lending rates is stable through the crisis, and the pass through of costs is consistent with the banks’ behaviour prior to the crisis.

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CFCM Discussion Paper 15/05, Why Did Bank Lending Rates Diverge from Policy Rates After the Financial Crisis by Anamaria Illes, Marco Lombardi and Paul Mizen

Authors

Anamaria Illes, Marco Lombardi and Paul Mizen

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