An Empirical Analysis of Asymmetric Responses of Sri Lankan Commercial Banks to Monetary Policy

Abstract

This study investigates how Sri Lankan commercial banks respond to countercyclical monetary policy over the post economic liberation 1990:06-2011:11period when the latest data available. First, the ous unit root test function with the intercept, slope, and trend were specified and estimated to test the hypothesis that the Sri Lankan commercial bank lending-Central Bank discount rate spread has a unit root. The results of this test suggest that the Sri Lankan lending-discount rate spread followed a stationary trend process with a break date beginning in July 2006. Secondly, the threshold autoregressive (TAR) and the momentum threshold autoregressive (M-TAR) models are estimated. The Akaike information Criterion (AIC) and the Schwarz information criterion (SIC) indicate that the M-TAR model fits the sample data better than the TAR model. Therefore, the M-TAR model specification is utilized for further investigation in this study. The empirical findings suggest the asymmetrical response of Sri Lankan commercial banks to countercyclical monetary policy and monetary authority successfully utilizes monetary policy to achieve its objectives. Additionally, the results can interpreted as indications that the Sri Lankan commercial banks exhibit predatory pricing behavior, which is consistent with their monopolistic/oligopolistic operating environment. The estimation results of the Asymmetric Error Correction Model reveal bi-directional Granger causality between the Sri Lankan commercial banks lending rate and the Central Bank’s discount rate. Finally, the estimation results also describe the length of the impact lag of the Sri Lankan countercyclical monetary policy.