## sipea2025004

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**Canonical URL:** [sipea2025004](https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025004.pdf)

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### ECB Monetary Policy Passthrough to Bank Interest Rates During Tightening — Inflation Episode of 2021–23
- Inflation dynamics:
  - Euro area inflation increased from around 1 percent in early 2021 to a peak of 10.6 percent in October 2022.
  - Kosovo inflation increased from around 1 percent in early 2021 to a peak of 14 percent in July 2022.
  - Montenegro inflation peaked at 17.5 percent in November 2022.
  - Bulgaria inflation peaked at 18.7 percent in September 2022.
- Inflation synchronization:
  - Year-over-year inflation correlation with the euro area increased in the period following the pandemic compared to the five years preceding the pandemic, with a more pronounced increase in Kosovo and Montenegro.
- ECB policy tightening episode:
  - Between June 2022 and September 2023, the ECB policy rate increased from 0 percent to 4.5 percent.
  - This tightening was faster and stronger than the previous most substantial tightening episode (from 2 percent in December 2005 to 4.25 percent in September 2008).

### Response of Bank Rates in Kosovo to ECB Policy Tightening — Aggregate Observations & Comparisons
- Aggregate observation:
  - Both lending and deposit rates in Kosovo increased since the beginning of the ECB tightening cycle, but the passthrough was limited compared to the euro area and many regional peers.
- Key comparative changes (July 2022 / June 2022 to August 2023 / August 2023):
  - Non-financial corporations (NFC) loan rates:
    - Increased by 3 percentage points (pp) in the euro area (start of tightening to August 2023).
    - Increased by 0.9 pp in Kosovo (same period).
    - Increase in Montenegro: 1.1 pp.
  - NFC deposit rates:
    - Increased by 1.1 percentage points in Kosovo (close to levels observed in Bosnia and Herzegovina, and Bulgaria).
- Passthrough intensity (historical comparison):
  - Per one percentage point increase in ECB policy rate:
    - NFC loan rates increased by 0.7 pp on average during the recent tightening episode.
    - NFC loan rates increased by 0.9 pp on average during earlier tightening episodes.
- Initial level differences and convergence:
  - Loan and deposit rates in Kosovo were higher than in the euro area just before the ECB tightening measures.
  - Mortgage rates in the euro area in August 2023 were lower than mortgage rates in Kosovo at the beginning of the tightening cycle in June 2022.
  - Weaker passthrough in Kosovo contributed to narrowing gaps between Kosovo bank rates and euro area average rates during the tightening.
- Private sector credit and profitability:
  - During the recent ECB tightening, private sector credit growth was larger and banks were more profitable in Kosovo than in comparator economies.
  - Bank profitability in Kosovo remained stronger than in comparator economies, although the gap narrowed.

### Factors Behind Low Interest Rate Passthrough
- Three key factors identified as most relevant to the limited passthrough in Kosovo: financial development, banking sector liquidity, and bank concentration.
- Financial development:
  - Dimensions: financial deepness, inclusion, and efficiency.
  - Offsetting forces during tightening:
    - ECB tightening exerted upward pressure on bank rates.
    - Ongoing financial development (acceleration of private credit growth, improved financial inclusion measures such as free basic accounts, adoption of online loan applications, improved risk management and supervision) exerted downward pressure on already high rates.
  - Financial inclusion:
    - Latest statistics available are from 2021 and indicate financial inclusion in Kosovo remains well below levels seen in other economies in the region.
- Liquidity:
  - Ample liquidity in Kosovo’s banking system during the ECB tightening likely reduced banks’ incentives to attract additional deposits, contributing to weaker passthrough to deposit rates.
  - Indicators and specific changes:
    - Loan-to-deposit ratio in Kosovo was lower compared to the euro area.
    - Kosovo had a higher ratio of liquid assets to short-term liabilities relative to some large European economies (France, the Netherlands, Spain).
    - Remuneration on excess reserves increased from -0.7 percent to 0 percent in August 2022.
    - Bank excess reserves held at the Central Bank of Kosovo declined significantly during the ECB tightening, indicating banks used existing liquidity rather than attracting deposits.
- Bank concentration:
  - Kosovo exhibits higher bank concentration compared to the euro area average, which is identified as a factor limiting competitive responses and thereby weakening passthrough.

### Bank concentration and monetary policy passthrough (Section 2)
- Higher bank concentration, measured through the Herfindahl index of total assets of credit institutions, indicates lower competition and possibly lower passthrough of monetary policy rates to deposit rates during tightening episodes (Kho 2023).
- Banks in Kosovo may not need to compete as strongly to attract deposits.
- This observation is in line with the strong profitability ratios experienced in the banking sector of Kosovo in 2022–23.
- In Kosovo, the impact of high bank concentration may be amplified by the fact that banks are dominant players in the financial sector as other forms of financial intermediation are relatively underdeveloped.

### Liquidity conditions during tightening episode (Section 2)
- One dimension of increased liquidity: government securities held by private banks have not been rolled over and as a result the banking sector had around €50 million of extra liquidity during the tightening episode.

### Implications and key takeaways (Section 2)
- High deposit-market concentration can weaken monetary policy transmission to deposit rates in tightening cycles.
- Strong bank profitability in 2022–23 is consistent with reduced competitive pressure on deposit pricing.
- Underdeveloped nonbank financial intermediation amplifies the role of banks, potentially intensifying the effects of concentration on monetary transmission.

*Prepared by Ezgi Ozturk; IMF staff paper completed on December 4, 2024 (SIP/2025/004).*

### Section 1

### ECB Monetary Policy Passthrough to Bank Interest Rates During Tightening

### A. Inflation Episode of 2021–23
- Inflation dynamics:
  - Euro area inflation increased from around 1 percent in early 2021 to a peak of 10.6 percent in October 2022.
  - Kosovo inflation increased from around 1 percent in early 2021 to a peak of 14 percent in July 2022.
  - Montenegro inflation peaked at 17.5 percent in November 2022.
  - Bulgaria inflation peaked at 18.7 percent in September 2022.
- Inflation synchronization:
  - Year-over-year inflation correlation with the euro area increased in the period following the pandemic compared to the five years preceding the pandemic, with a more pronounced increase in Kosovo and Montenegro.
- ECB policy tightening episode:
  - Between June 2022 and September 2023, the ECB policy rate increased from 0 percent to 4.5 percent.
  - This tightening was faster and stronger than the previous most substantial tightening episode (from 2 percent in December 2005 to 4.25 percent in September 2008).

### B. Response of Bank Rates in Kosovo to ECB Policy Tightening
- Aggregate observation:
  - Both lending and deposit rates in Kosovo increased since the beginning of the ECB tightening cycle, but the passthrough was limited compared to the euro area and many regional peers.
- Key comparative changes (July 2022 / June 2022 to August 2023 / August 2023):
  - Non-financial corporations (NFC) loan rates:
    - Increased by 3 percentage points (pp) in the euro area (start of tightening to August 2023).
    - Increased by 0.9 pp in Kosovo (same period).
    - Increase in Montenegro: 1.1 pp.
  - NFC deposit rates:
    - Increased by 1.1 percentage points in Kosovo (close to levels observed in Bosnia and Herzegovina, and Bulgaria).
- Passthrough intensity (historical comparison):
  - Per one percentage point increase in ECB policy rate:
    - NFC loan rates increased by 0.7 pp on average during the recent tightening episode.
    - NFC loan rates increased by 0.9 pp on average during earlier tightening episodes.
- Initial level differences and convergence:
  - Loan and deposit rates in Kosovo were higher than in the euro area just before the ECB tightening measures.
  - Mortgage rates in the euro area in August 2023 were lower than mortgage rates in Kosovo at the beginning of the tightening cycle in June 2022.
  - Weaker passthrough in Kosovo contributed to narrowing gaps between Kosovo bank rates and euro area average rates during the tightening.
- Private sector credit and profitability:
  - During the recent ECB tightening, private sector credit growth was larger and banks were more profitable in Kosovo than in comparator economies.
  - Bank profitability in Kosovo remained stronger than in comparator economies, although the gap narrowed.

### C. Factors Behind Low Interest Rate Passthrough
- Overview:
  - Three key factors identified as most relevant to the limited passthrough in Kosovo: financial development, banking sector liquidity, and bank concentration.
- Financial development:
  - Financial development dimensions: financial deepness, inclusion, and efficiency.
  - Offsetting forces during tightening:
    - ECB tightening exerted upward pressure on bank rates.
    - Ongoing financial development (acceleration of private credit growth, improved financial inclusion measures such as free basic accounts, adoption of online loan applications, improved risk management and supervision) exerted downward pressure on already high rates.
  - Financial inclusion:
    - Latest statistics available are from 2021 and indicate financial inclusion in Kosovo remains well below levels seen in other economies in the region.
- Liquidity:
  - Ample liquidity in Kosovo’s banking system during the ECB tightening likely reduced banks’ incentives to attract additional deposits, contributing to weaker passthrough to deposit rates.
  - Indicators and specific changes:
    - Loan-to-deposit ratio in Kosovo was lower compared to the euro area.
    - Kosovo had a higher ratio of liquid assets to short-term liabilities relative to some large European economies (France, the Netherlands, Spain).
    - Remuneration on excess reserves increased from -0.7 percent to 0 percent in August 2022.
    - Bank excess reserves held at the Central Bank of Kosovo declined significantly during the ECB tightening, indicating banks used existing liquidity rather than attracting deposits.
- Bank concentration:
  - Kosovo exhibits higher bank concentration compared to the euro area average, which is identified as a factor limiting competitive responses and thereby weakening passthrough.

*Prepared by Ezgi Ozturk; IMF staff paper completed on December 4, 2024 (SIP/2025/004).*

### Section 2

### Section 2

### Bank concentration and monetary policy passthrough
- Higher bank concentration, measured through the Herfindahl index of total assets of credit institutions, indicates lower competition and possibly lower passthrough of monetary policy rates to deposit rates during tightening episodes (Kho 2023).
- Banks in Kosovo may not need to compete as strongly to attract deposits.
- This observation is in line with the strong profitability ratios experienced in the banking sector of Kosovo in 2022–23.
- In Kosovo, the impact of high bank concentration may be amplified by the fact that banks are dominant players in the financial sector as other forms of financial intermediation are relatively underdeveloped.

### Liquidity conditions during tightening episode
- One dimension of increased liquidity: government securities held by private banks have not been rolled over and as a result the banking sector had around €50 million of extra liquidity during the tightening episode.

### Implications and key takeaways
- High deposit-market concentration can weaken monetary policy transmission to deposit rates in tightening cycles.
- Strong bank profitability in 2022–23 is consistent with reduced competitive pressure on deposit pricing.
- Underdeveloped nonbank financial intermediation amplifies the role of banks, potentially intensifying the effects of concentration on monetary transmission.

*Source: sipea2025004 - Section 2*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025004.pdf_