Economic Bulletin

Economic Bulletin Number 28, February 2007 Economic Bulletin Number 28, February 2007 BANK OF GREECE 21, E. Venizelos Avenue 102 50 Athens www.bankofgreece.gr Economic Research Department - Secretariat Tel. +30210 320 2392 Fax +30210 323 3025 Printed in Athens, Greece at the Bank of Greece Printing Works ISSN 1105 - 9729 Contents Determinants of bank interest rates and comparisons between Greece and the euro area Sophocles N. Brissimis Thomas Vlassopoulos 7 Borrowing and socio-economic characteristics of households: results of sample surveys carried out by the Bank of Greece George T. Simigiannis Panagiota G. Tzamourani 31 Education, labour market and wage differentials in Greece Evangelia Papapetrou 51 The evolution of credit risk: phenomena, methods and management George A. Christodoulakis 75 Inflation measurement in Greece Nikos P. Karabalis Euripides K. Kondelis 83 Working Papers 97 Monetary policy and financial system supervision measures 111 Decisions of the Bank of Greece 115 Statistical section 139 Articles published in previous issues of the Economic Bulletin 165 6 ECONOMIC BULLETIN, 28 2/07 Determinants of bank 1. Introduction interest rates and Since the mid-1990s, bank interest rates in comparisons between Greece have recorded a significant decline. The Greece and the euro rate on loans without a defined maturity to enterprises, for instance, stood at 7.35% at the end of area* 2006, compared with 26.40% at the end of 1994. Similarly, the rate on savings deposits fell to 1.09% at the end of 2006, from 15.10% at the end of 1994. This development in bank interest rates was largely related to the Greek economy’s nom- inal convergence process in view of the country’s participation in Stage III of EMU, while for the period after the country’s entry into the monetary union it reflects the monetary stability that Greece Sophocles N. Brissimis benefits from as a member of the euro area. At the Bank of Greece same time, interest rate developments have been Economic Research Department affected by the process of deregulation of the University of Piraeus banking system, which was completed in this Department of Economics period – a step that was to some extent necessary for the country to qualify for EMU entry. Thomas Vlassopoulos Specifically, the elimination of the public sector’s Bank of Greece privileged access to the banking system and the Economic Research Department alignment of the framework regarding banks’ min- imum reserves deposited with the Bank of Greece with that of the Eurosystem have removed these cost elements that previously weighed on the bank intermediation process. However, despite the significant decline in interest rates and the single monetary policy pursued throughout the euro area, bank interest rates in Greece in general continue to stand above euro area averages, and in fact the differential in the * The authors would like to express their gratitude to Heather Gibson, Isaac Sabethai and George Simigiannis for their helpful comments. The article reflects the views of the authors and not necessarily those of the Bank of Greece. ECONOMIC BULLETIN, 28 2/07 7 case of some banking products is considerable. and empirical literature and attempts to relate For instance, in consumer loans without a defined them to the Greek experience. The fourth section maturity the differential of the Greek rate over the makes specific reference to the rate differentials euro area average was 3.77 percentage points at among the euro area countries, while the fifth sec- the end of 2006, while in consumer loans with a tion presents some concluding remarks. fixed rate for a period of more than one and up to five years it was 2.85 percentage points.1 It must be noted of course that rates higher than the euro 2. Theoretical approaches for the area average are also observed in other members determination of the interest rate spread of the monetary union2,3 and that the differentials of the Greek rates over the euro area rates are The theoretical approaches that have been pro- generally on a downward path. Whereas rates on posed in the international literature on the deter- deposits in Greece are also higher than in the euro mination of bank interest rates generally fall area, the interest rate spread4 in the Greek bank- within the domain of the theory of industrial ing system is wider (by 1.53 percentage points at organisation. From this perspective, banks are the end of 2006), although this margin has shrunk seen not as one industry —as is the case e.g. in in recent years.5 monetary theory (Freixas and Rochet, 1997)— but as independent firms that respond to the external The persistence of the Greek rates and interest financial environment. Moreover, banks are rate spread above euro area levels has fuelled a thought to operate —simultaneously— as buyers public debate, as it implies a higher bank intermediation cost compared with the average in the monetary union, with possible implications for 1 These differentials are mentioned here indicatively, since to some extent they reflect the different compositions of the specific the consumption and investment decisions of loan categories in Greece and the euro area average as regards the individual products they comprise (e.g. loans through credit cards households and enterprises, and by extension for and credit lines). growth, perhaps even for income distribution 2 See European Central Bank (2006a). 3 Interest rate differentials have also been recorded within indi- within the economy. The present study aims at vidual countries – see e.g. Jappelli (1987) on interest rate differ- contributing to this discussion, by presenting a entials between ¡orth and South Italy, as well as the historical study by Eichengreen (1984) on the States of the US at the end of review of the literature on the determinants that the 19th century. However, more recently a much lower interest rate dispersion is detected among the States of the US than among shape bank interest rates and rate spreads inter- the countries of the euro area – see European Central Bank nationally, and by attempting to identify factors (2005a), pp. 127-28). 4 The interest rate spread is defined as the difference between the that may explain the differentials between the weighted average interest rate on the total of bank loans and the Greek and the corresponding euro area rates. respective interest rate on the total of bank deposits. In general however, the interest rate spread is measured as the difference between interest income and interest expenses, as a percentage of the average interest-bearing assets (interest rate margin). The following section reviews the major theoreti- Although the two terms are not necessarily identical, following the cal approaches proposed in the literature for the practice usually observed in the literature (see e.g. Ho and Saunders, 1981; Wong, 1997; and Saunders and Schumacher, determination of interest rate spread levels. The 2000) they are used here interchangeably. third section goes through the key determinants 5 In the five-year period between 2001 and 2005 the interest rate spread narrowed by 1.21 percentage points – see Bank of Greece of rates and rate spreads cited in the theoretical (2006b). 8 ECONOMIC BULLETIN, 28 2/07 Determinants of bank interest rates and comparisons between Greece and the euro area of deposits and sellers of loans, and therefore Therefore, according to the dealership model, the their decisions about the levels of deposit and existence of the interest rate spread is essentially a lending rates are directly interconnected.6 Thus, result of the uncertainty banks face when they the focus of attention is the study of the factors accept deposits or extend loans at each particular that shape the difference between these two point in time, and of the cost this uncertainty rates, i.e. the interest rate spread. At the same implies. The same model argues that the optimum time, owing mainly to the considerable entry bar- interest rate spread depends on: (i) the structure riers that characterise the banking industry, of the banking market (i.e. the degree of competi- approaches based on markets that operate under tion that characterises the particular market); conditions of imperfect competition (see e.g. (ii) the volume of banking transactions (i.e. the Klein, 1971; and Monti, 1972) are considered to average level of deposits and loans); (iii) the be more appropriate for the study of banking volatility of the interest rates; and (iv) the degree firms compared with models that assume per- to which the bank’s management is risk averse.7 fectly competitive markets. The Ho and Saunders (1981) model provides a Two basic theoretical paradigms have been pro- simple, yet well-grounded theoretical framework posed in the literature for the determination of that accounts for the interest rate spread and is interest rate spreads, the dealership model and the empirically readily applicable, but nevertheless microeconomic model of the banking firm. The has important limitations. In particular, this model dealership model was originally used for studying takes no account of the credit risk inherent in the differential between ask and bid prices set by loans or the “production” cost entailed by the stock market dealers (see e.g. Stoll ,1978). Ho and intermediation process,8 and also assumes that Saunders (1981) used this model to study the the bank accepts only one type of deposit and determination of the interest rate spread, viewing offers only one type of loan. Later studies tackle the bank as an intermediary between the financial the shortcomings of this original model through entities supplying funds and those demanding more comprehensive variations of the dealership them. During this intermediation the bank faces model. More specifically, Allen (1988) presents an uncertainty as it cannot know the exact level of extension of the above model in which the bank deposits it will receive or of loans it will be called offers numerous types of deposits and loans.

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