Banks’ net interest rate spread and the transmission of monetary policy in Korea

In the transmission of monetary policy, banks’ administered interest rates set by their market power may not coordinate well with the policy intention. In this study, we examine the effect of banks’ net interest rate spread (NIS) on real economic growth in response to changes in the benchmark interest rate in Korea. We find that the market power component of the NIS interacting with the benchmark rate significantly affects the prediction of future economic growth, especially under loosening monetary policy. Our findings indicate that when the policy interest rate decreases to boost the economy, monopolistic banks widen the NIS by sluggishly adjusting the lending rate, which dampens the growth effect. This misalignment remains consistent when we focus on the subperiod after the 2008 financial crisis and use alternative measures for our main variables.