Adjustment of commercial banks' interest rates and the effectiveness of monetary policy : evidence from Anglophone West Africa

Bangura, Lamin (2011) Adjustment of commercial banks' interest rates and the effectiveness of monetary policy : evidence from Anglophone West Africa. Masters thesis, Rhodes University.

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Abstract

Most central banks use short-term interest rates as their main instrument of monetary policy. It is assumed that a change in policy rate will influence interest rates set by commercial banks, but this is not usually the case. Commercial banks adjust their interest rates in response to changes in policy rate with lags, which make their interest rates sticky. Stickiness in commercial banks interest rates have been seen as an obstacle to the smooth transmission of monetary policy decisions. Despite the importance of the transmission process, little attention has been given to a systematic measurement of the degree of response of commercial banks‟ interest rates to changes in monetary policy stance in the Anglophone West African countries, specifically within the West African Monetary Zone (WAMZ) economies. Against this backdrop, this study explores the interest rate adjustment dynamics using monthly interest rate series on discount rate, treasury bill rate, commercial banks‟ deposit and lending rates from 1989 to 2009 (for Gambia, Nigeria and Sierra Leone) and from 2000 to 2009 (for Ghana). Specifically, the study set out to examine how lending and deposit rates respond to changes in the official rates and to see whether there is a convergence among the rates over time. Also, to examine the relative adjustment of commercial bank lending rates to changes in the official rate when there is disequilibrium. The analyses were twofold: a full sample period and a rolling window analysis. Following Cottarelli and Kourelis (1994), the study employed cointegration technique and an asymmetric error correction model to obtain the short-run and long-run parameters from which the error correction coefficients, mean adjustment lags and asymmetric mean adjustment lags were estimated. The results for the entire sample period revealed that the long-run pass-through in Nigeria was 81% and 67% for lending rates and deposit rates respectively. In Ghana, it was 66% and 69% for lending and deposit rates respectively. While in Sierra Leone, long-run pass-through was 62% and 72% for lending and deposit rates respectively. In Gambia, it was 50% and 40% for lending and deposit rates respectively. On the other hand, the short-run pass-through was found to be lower compared to the long-run pass-through: in Nigeria it was 66% and 47%; in Gambia, 26% and 29%; in Sierra Leone, 30% and 13%; and in Ghana, -6% and 35% for lending and deposit rates respectively in each country. The pass-through estimates for the rolling windows were mixed for short-run and long-run pass-through. The mean adjustment lags suggest that the speed of adjustment of Lending rates for full sample period were two, two, seven and twelve months in Nigeria, Ghana, Sierra Leone and Gambia respectively. While for deposit rates they were five, six, seven and eighteen for Ghana, Nigeria, Gambia and Sierra Leone respectively. The average speeds of adjustment for the rolling windows were four and five months for lending and deposit rates respectively. Weak evidence of convergence was found in lending and deposit rates in the short-run and long-run pass-through among the countries. However, the results suggest that the magnitude and speed of the pass-through amongst the countries on average were high compared to emerging Asian countries. Significant asymmetric adjustments were found in the lending rates for Gambia and Sierra Leone, while in Gambia and Nigeria there were asymmetries in deposit rates. Based on the evidence provided, interest rate pass-through is high in Nigeria and Ghana compared to Gambia and Sierra Leone and this calls for the harmonization of financial policies on the part of the financial authorities in the WAMZ. Viewed solely from an interest rate pass-through, the lack of convergence among the countries suggests that WAMZ is far from ready for a monetary union. The relatively low pass-through in some of the countries suggests rigidity in the banking system which may be due to underdevelopment of the system. Thus efforts geared toward strengthening the banking system and the financial system as whole would further enhance the prospect of a monetary union among them.

Item Type:Thesis (Masters)
Uncontrolled Keywords:Monetary policy, West Africa, Banks and banking, Interest rates
Subjects:H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
Divisions:Faculty > Faculty of Commerce > Economics and Economic History
ID Code:2104
Deposited By: Ms Chantel Clack
Deposited On:13 Oct 2011 08:23
Last Modified:06 Jan 2012 16:22
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