Key Takeaways
- Lending practices vary across euro area countries, impacting how monetary policy changes affect loan interest rates.
- A key difference lies in the maturity of the overnight interest rate swap (OIS) used as the risk-free rate benchmark for new loans.
- Countries like Latvia and Estonia use shorter OIS maturities, while the Netherlands and France use longer ones.
- The maturity of the risk-free rate significantly influences the speed and strength of monetary policy transmission to lending rates.
- Banks adjust loan premiums to partially offset differences in how interest rate changes are passed through to borrowers.
Monetary Policy Transmission and Lending Differences
Although the euro area shares a single currency and a common monetary policy, the way banks lend money differs significantly from one country to another. These variations play a crucial role in how changes in monetary policy are passed on to borrowers. A recent study delved into a less-examined aspect: the maturity of the relevant overnight interest rate swap (OIS) when new loans are issued. The analysis utilized data from AnaCredit, a comprehensive database covering approximately seven million new loans granted by banks to non-financial corporations (NFCs) across the euro area between 2022 and 2023. This period notably includes the series of interest rate hikes implemented after the pandemic.
Preliminary findings indicate that standard structural factors, such as the type of loan, the size of the borrowing company, or the loan’s own maturity, account for only a small fraction of the disparities in lending rates observed across euro area nations. This suggests that other loan-specific characteristics hold greater influence.
The research framework decomposes the interest rate on individual loans into two components: a ‘relevant risk-free rate’ and a ‘premium’. The premium represents the additional charge banks levy to compensate for risk, calculated as the residual after accounting for the risk-free rate. For fixed-rate loans, the OIS maturity directly matches the loan’s term. For floating-rate loans, the relevant risk-free rate’s maturity corresponds to the duration of the loan’s benchmark rate at the time of issuance. For instance, a five-year fixed-rate loan would be benchmarked against a five-year OIS rate on its issuance date. Conversely, a five-year floating-rate loan, pegged to a three-month EURIBOR that resets quarterly, would use the three-month OIS rate as its relevant risk-free rate. The premium is then simply the lending rate minus this identified relevant risk-free rate.
Cross-Country Variation in Risk-Free Rate Maturities
The study uncovered striking differences among euro area countries regarding the maturity of these relevant risk-free rates. In nations such as Latvia and Ireland, the average maturity of these benchmarks is quite short, hovering around six months. In stark contrast, countries like the Netherlands, Malta, and France frequently utilize risk-free rates with maturities exceeding five years on average.
Loan Characteristics Shape Policy Pass-Through
These structural variations mean that monetary policy influences lending rates with different intensity and at different speeds across the euro area. The effectiveness depends on which part of the risk-free yield curve is dominant in local lending practices. This leads to two key questions: To what extent do the differing trends in risk-free rates used for pricing corporate loans explain the cross-country variations in the rise of average interest rates on new loans between early 2022 and late 2023? And importantly, how does the maturity of the relevant risk-free rate affect the transmission of monetary policy rate changes to the interest rates on newly issued loans?
Analyzing Lending Rate Changes Before and After Policy Shifts
To investigate the first question, the researchers adopted a time-difference approach, comparing interest rates and their components (relevant risk-free rates and premiums) on loans issued in two distinct periods. These periods bracket the 2022-23 interest rate tightening cycle. The first period is the first quarter of 2022, preceding the initial rate hike in July 2022. The second period is the fourth quarter of 2023, following the final hike in September 2023. The analysis revealed that the majority of the increase in interest rates on new loans during this post-pandemic tightening phase was driven by the rise in the relevant risk-free rate, as depicted in Figure 2.
Three significant observations emerged from this part of the study:
- The pass-through of changes in relevant risk-free rates to lending rates displayed notable cross-country variation. Eleven countries saw increases in relevant risk-free rates of over four percentage points, with Latvia and Estonia experiencing the highest jumps (4.37-4.41 percentage points). In contrast, the Netherlands and Malta observed smaller increases in risk-free rates, around 2.85 percentage points.
- The distinction between fixed and floating-rate loans did not consistently explain these patterns. The rise in relevant risk-free rates was particularly pronounced in countries like Latvia and Ireland, where floating-rate loans with shorter fixation periods are more common. Similarly, Italy showed a strong contribution from relevant risk-free rates, despite its higher prevalence of fixed-rate loans, which typically have shorter maturities.
- A substantial increase in relevant risk-free rates did not always translate into the largest increase in overall lending rates. In several countries, the rise in risk-free rates was counterbalanced by a decrease in the premium, moderating the total increase in lending rates.
Monetary Policy Rate Pass-Through to Lending Rates
The researchers then focused on loans issued around the dates of European Central Bank (ECB) Governing Council meetings. They employed a stacked time-difference regression method, a more sophisticated approach than a simple before-and-after comparison, to examine how the pass-through of monetary policy rate changes varies across loans priced using different maturities of relevant risk-free rates. This analysis used actual changes in the policy rate, instrumented by high-frequency surprises, to account for the full scope of policy shifts. The findings, illustrated in Figure 3, indicate that the pass-through from monetary policy rates to lending rates becomes stronger as the maturity of the relevant risk-free rates shortens.
However, when examining the components of interest rates, it becomes clear that this direct pass-through isn’t the sole determinant. Adjustments in loan premiums also play a role in smoothing out differences in pass-through across various loan categories. Specifically, the study found that premiums increased less for loans tied to shorter-maturity risk-free rates, which helps to offset some of the disparities in the aggregate pass-through to overall lending rates.
Several factors may explain this observed pattern. On the lender’s side, the repricing of loans can sometimes outpace the pass-through of funding costs, leading to improved net interest income. This can create room for banks to lower premiums on new loans, particularly those benchmarked against short-term rates. From the borrower’s perspective, tighter monetary policy can alter the composition of borrowing, potentially leading firms to shift their borrowing across different maturities and rate types.
💡 Overall, the evidence points towards systematic smoothing effects: adjustments in loan premiums tend to dampen the differences in overall loan rate changes. This suggests that the observed variations are more likely a reflection of pricing strategies within financial institutions rather than shifts in the types of banks providing the lending.
Loan Pricing Design is Key for Monetary Policy Effectiveness
The findings of this research have several important implications for the conduct of monetary policy. Firstly, the specific design of loan pricing significantly influences how effectively monetary policy is transmitted through the financial system. Markets where lending is predominantly linked to shorter-term interest rates tend to experience a stronger and more rapid transmission of policy changes.
Secondly, loan premiums are not static and can adjust independently of external factors. When short-term interest rates experience sharp movements, banks adapt the loan premiums over the relevant risk-free rate in ways that help to minimize differences across loans priced using various maturities. Understanding this dynamic interaction is crucial for explaining cross-country variations observed during periods of monetary tightening and for anticipating how the composition and pricing of new credit will respond to policy actions.
Final Thoughts
This analysis highlights how country-specific lending practices, particularly the maturity of benchmark interest rates used for new loans, significantly impact the transmission of monetary policy across the euro area. The research underscores that while direct pass-through of policy rate changes is evident, banks’ adjustments to loan premiums play a vital role in smoothing these effects and contribute to observed cross-country heterogeneity.