The Effects of Banking Competition on Monetary Policy Transmission

Monetary policy aims to influence the real economy using policy rates. However, banks often operate in markets characterized by imperfect competition, affecting the transmission of these policy rates as the banks retain part of the adjustment as profits. As a consequence, the level of interbank competition in a relevant market for banking services, which for SME loans and consumer banking typically is national, affects the policy rate pass-through. The impact of central monetary policy may therefore work out different decentrally in the Member States with different competitive banking regimes locally. For these reasons, diverse partial pass-through and its microeconomic foundations should be taken into account when determining the optimal policy rate. They are an instrument for differentiated monetary policy within one monetary union. That is, as monetary policy at central bank level is likely to impact the real economies of the Member States differently, it offers a channel for policy differentiation to national needs. This thesis presents a comprehensive model of banking competition and policy rate pass-through to study this largely unexplored dimension of monetary policy. It finds that policy rate transmission is weaker (stronger) than under perfect competition when deposit supply and lending demand are log-concave (log-convex). As a result, within a monetary union, it is optimal to promote a higher (lower) degree of banking competition in countries with larger fluctuations in GDP and inflation in the log-concave (log-convex) case.