Deposit market power dampens monetary policy transmission
A new Banca d'Italia working paper reveals that banks' deposit market power and deposit funding significantly muted the pass-through from ECB policy rates to overnight deposit rates during the 2022-23 tightening cycle. This disconnect in monetary policy transmission also extended to lending rates for households and non-financial corporations.
Muted pass-through to deposits
During the European Central Bank's (ECB) forceful monetary tightening in 2022-23, the pass-through from policy rates to overnight deposit rates was notably muted compared to historical patterns, indicating a significant disconnect in monetary policy transmission.
Using confidential bank-level data and high-frequency monetary policy shocks, the study found that higher deposit funding is associated with a lower pass-through to overnight deposit rates, primarily in the short term.
The dampening effect of deposit market power is more persistent, extending to lending rates for households and non-financial corporations, thereby impacting broader financing conditions.
Banks with higher deposit market power also showed a more pronounced increase in their average loan-deposit spread, as the overall dampening effect on overnight deposit remuneration was greater than that on lending rates.
This highlights how market power limited the transmission of policy rate hikes to depositors.
ChaMP network's focus
The paper, part of the Challenges for Monetary Policy Transmission in a Changing World Network (ChaMP), revisits monetary transmission channels in the euro area.
This network, comprising economists from the ECB and national central banks, aims to understand policy transmission amid unprecedented shocks and structural changes.
The study focuses on banks' deposit market power and deposit funding as key drivers, factors that gained relevance during the preceding long phase of accommodative monetary policy.
Between 2015 and 2021, large deposit inflows and low opportunity costs for holding money allowed some banks to strengthen their deposit market power.
This context is crucial for understanding the observed disconnect in monetary policy transmission.
A crucial disconnect revealed
The study effectively highlights a critical disconnect in monetary policy transmission, offering granular insights into banks' role.
Its findings challenge conventional assumptions about rate pass-through, particularly concerning deposit market power.
For central banks, this research underscores the need to consider structural banking sector dynamics when calibrating policy.