The effect of open market interest rates on Malaysian commercial banks interest rates spread: an empirical analysis

Abstract

In this paper we investigate the effect of changes in open market interest rates on the interest rates spread of Malaysian commercial banks. This is performed by examining the causality and patterns of reactions of the banking rates with respect to variation in open market rates. Based on the vector autoregression analysis we show that there is one way causation running from the open market rates to banking rates. Changes in open market rates significantly causes changes in the spread and deposits rates. However, no significant causation is identified for lending rates. The impulse response functions indicate that spread decline following positive innovation in open market rates and this is mainly due to the greater sensitivity of deposit rates to open market rates. The response of lending rates are shown to be low and occur with some lag, thus, contributing to the decline in spread. We also provide evidence of dichotomy between banks assets and liabilities rates by failing to support causality between the two rates. It is argued that this imbalance of sensitivity is partly due to the uneven process of interest rate liberalization which frees deposit rates more than lending rates. These results suggest that for the Malaysian banking firms, increase in open market rates hindered their profitability and not a good news to the bankers.