Interest Rate Pass-through in Sri Lanka

The Central Bank of Sri Lanka has increasingly been relying on interest rates as the instrument for conducting monetary policy. Changes to the key monetary policy variables, the Repo and the Reverse Repo rates, are initially expected to be reflected in the OMO rates and the call money market rates, before being passedthrough to commercial bank retail interest rates. It is important to obtain a good understanding of the speed and magnitude of the interest rate pass-through to make timely monetary policy decisions in order to meet the objective of economic and price stability. This paper examines the size and speed of the pass-through from policy interest rates to call money market rates and from call money market rates to commercial bank retail interest rates. The paper concludes that the CBSL policy decisions are efficiently transmitted to the short end of the money market within a matter of days. Also, the pass-through from policy interest rates to the call money market rate is almost complete. However, the pass-through from call money market rates to both lending rates and deposit interest rates of commercial banks is sluggish and incomplete. The only exception is, perhaps, the rates on lending to prime customers, which show a faster and a fuller pass-through. Also, there is no evidence of an asymmetry of pass-through over different phases of the interest rate cycle.