How do loan characteristics influence the transmission of monetary policy in the euro area? This question is particularly important given the significant heterogeneity in these characteristics across member states. New empirical research, utilizing loan-level data, highlights this heterogeneity for the maturity of risk-free rates, to which lending rates are tied. It then shows that such heterogeneity feeds through into the strength of monetary policy transmission. 

It is well established that credit markets across euro area member states display significant heterogeneity along various dimensions (Altavilla et al., 2024; Kosekova et al., 2023). From a central bank perspective, this raises an important question: how do these dimensions influence the transmission of monetary policy? New empirical research conducted by economists from several euro area national central banks and the ECB as part of the ChaMP Research Network focuses on one new dimension: the maturity of risk-free rates, to which rates on loans to non-financial corporations (NFCs) are tied.

Crucial for monetary policy transmission: the relevant risk-free rate

The relevant risk-free rate identifies which segment of the risk-free yield curve is relevant for the pricing of a loan. To determine this rate, the recent ChaMP/Bundesbank research paper leverages granular loan-level information from the AnaCredit dataset. The relevant risk-free rate is a market rate devoid of default risk, to which the rate on a loan is tied. We assume it corresponds to an overnight index swap (OIS) rate, since these rates are considered default-free and are available for a broad spectrum of maturities. For each loan, we define the relevant risk-free rate as an OIS rate with a specific maturity derived from its characteristics: for fixed-rate loans the loan’s maturity, and for floating-rate loans the maturity of the market rate to which the loan is indexed. 

Average maturities of relevant risk-free rates for loans to NFCs differ significantly across euro area countries. They range from approximately six months in Latvia and Ireland to over six years in the Netherlands. At the same time, the changes in OIS rates during the monetary policy tightening phase between early 2022 and late 2023 varied across maturities. The increase amounted to almost 4.5 percentage points for a six-month maturity but only to about 2.5 percentage points for a six-year maturity.  

Heterogeneity in the relevant risk-free rates translated into heterogeneity in lending rate changes during the monetary policy tightening phase. Figure 1 depicts the change in lending rates between the first quarter of 2022 and the fourth quarter of 2023. To make sure the measured change was not driven by loan and borrower characteristics, the estimation controls for a broad range of these characteristics. The change is decomposed into two components: the change in the relevant risk-free rate, and the change in the premium. The premium is defined as the amount by which the lending rate is marked up over the relevant risk-free rate. Countries where the relevant risk-free rate had shorter average maturities, such as Latvia and Ireland, saw this rate contribute the most to the increase in lending rates. In contrast, countries with longer average maturities, such as the Netherlands, saw a significantly smaller contribution. This highlights that heterogeneity in the relevant risk-free rates resulted in heterogeneity in the transmission of monetary policy. However, Figure 1 also shows that in several countries, the change in the premium counteracted the effect of the relevant risk-free rate.  

Further econometric analysis confirms that changes in the premium dampened the impact of the relevant risk-free rate on monetary policy pass-through. The tightening of monetary policy had a stronger effect on loans linked to risk-free rates with shorter maturities. However, the difference in the strength of pass-through was less pronounced than it would have been under a purely “mechanical” pass-through of changes in the relevant risk-free rate. This suggests that certain factors helped to moderate – though not entirely eliminate – the influence of the relevant risk-free rate on the transmission of monetary policy to lending rates. 

Smoothing of relevant risk-free rate effects merits further research

 The research findings suggest that the relevant risk-free rate is an important determinant for the strength of monetary policy transmission. This rate serves as a link between the impact of monetary policy on the shape of the risk-free yield curve and its effect on lending rates. The results indicate that the effects of the monetary policy tightening in 2022 and 2023 on the risk-free yield curve were transmitted to lending rates in a smoothed manner. Both bank-specific and borrower-specific factors could potentially explain this smoothing. Further research is required to gain a deeper understanding of these underlying factors.

References

Altavilla, C, R S Gürkaynak, and R Quaedvlieg (2024), Macro and micro of external finance premium and monetary policy transmission, Journal of Monetary Economics 147, 103634. 

Kosekova, K, A Maddaloni, M Papoutsi, and F Schivardi (2023), Firm-bank relationships: a cross-country comparison, European Central Bank, Working Paper Series No 2826.