The CNB, as part of the Eurosystem, participates in the creation of the common monetary policy based on the policy of managing key interest rates and also implements it in Croatia. When the ECB’s Governing Council, of which the Governor of the CNB is a member, changes key interest rates, this affects, to a greater or lesser extent, lending interest rates, interest rates on deposits with credit institutions and prices and/or yields of other investment instruments and, indirectly, the entire economy. Thus, although the ECB does not set the interest rates applied to corporate and household loans and deposits, the ECB’s interest rates do have an indirect impact on market interest rates.
The ECB’s Governing Council discusses monetary policy every six weeks, setting three interest rates: the rate for credit institutions’ overnight deposits with the central bank, the rate on the main refinancing operations and the rate on the marginal lending facility. The MRO rate defines the cost of borrowing by credit institutions from the central bank for one week. If credit institutions need money overnight, they can use the marginal lending facility, which is subject to a higher interest rate. In the current conditions of exceptionally high liquidity for the market, out of the three mentioned rates, the interest rate on credit institutions’ overnight deposits with the central bank is the most relevant.
A change in official central bank interest rates has a quick and direct impact on money market interest rates, i.e. interest rates in interbank trading in money by credit institutions. However, while the pass-through of key interest rates to the money market is almost complete and instant, the pass-through to interest rates on other loans and deposits is indirect and only gradual, over a certain period of time. Namely, a rise in financial market interest rates could encourage corporations and households to withdraw deposits from banks with relatively low deposit interest rates and invest them in alternative financial instruments such as bonds or money market fund shares, so banks need to raise deposit rates in order not to lose the deposit base. In such conditions, corporations and households also transfer deposits to banks with relatively higher interest rates, so that competition among banks additionally spurs the increase in the general level of interest rates. Furthermore, in the conditions of large excess liquidity that banks deposit with Eurosystem central banks and receive interest on them, the interest rate on overnight deposits determines the opportunity cost for banks of placing funds for some other purpose as well as the minimum return that banks will require when granting some types of loans. Finally, money market interest rates (e.g. EURIBOR), which are affected by the ECB’s monetary policy, are used as reference rates for calculating the interest rate on new loans.
The speed and the volume of interest rate pass-through may differ visibly because credit institutions determine their discretionary interest rates on deposits and loans under the influence of numerous factors, of which monetary policy is only one. Such factors may include competition, expectations, credit demand, regulation of interest rates, profitability of credit institutions and their capitalisation, etc. All this may affect differences in the volume and speed of pass-through of key interest rate changes to the financial market among countries and over time.
In addition to all of the above, it is necessary to distinguish the impact of the key ECB interest rates on existing loans and on new loans. In the case of existing loans, interest rate movements are regulated by the existing loan agreement. For example, if a fixed rate is agreed over the entire repayment period, movements in ECB and market rates will have no impact on the cost of loan repayment. On the other hand, in the case of loans with a variable interest rate, the cost of financing depends on the movement of the reference parameter agreed when the loans are granted, such as the national reference rate (NRR) or EURIBOR. In such cases, changes in key ECB interest rates also affect the cost of existing loans, which may differ significantly according to the agreed reference parameter for interest rate change. Thus, for example, in 2022 and 2023, the six-month euro NRR1 increased by only 0.1 percentage point, while the six-month EURIBOR increased by 4.4 percentage points at the same time.
Credit institutions set financing conditions for new loans by taking into account a number of the mentioned factors and bearing in mind that these conditions also affect the amount of loans applied for. Nevertheless, the freedom of credit institutions to set interest rates on new and existing loans is limited by a number of legal provisions.
Figure 1 Pass-through of key central bank interest rates to interest rates in the economy