Interest rate pass-through from policy rate to bank lending and deposit rates

Abstract

The paper analyses monetary policy transmission in India by studying the pass through of policy rates to bank lending and borrowing rates. A brief study of Indian monetary policy framework since 1994 has been done. Various channels of monetary policy transmission are studied and analysis is done to study the correlation with policy rates. The empirical study uses a Vector Auto Regression (VAR) and Vector Error Correction Model (VECM) to understand the interest rate pass-through. Relationship between policy rate and short term, long term interest rate is studied with its eventual impact on lending rates. For each analysis, the impact of policy rate is first studied on call rate and then the call rate on target rate. The analysis finds near complete pass-through with a small lag between repo rate and call rate. The short term interest rate (91 day T bills) and long term interest rate (G sec 10 yr) show similar high pass-through but with higher lags. The lending rate however does not show significant pass through.