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Macroeconomic Determinant of Banks Lending Rate in the Philippines
In Partial Fulfillment in the Subject
Macroeconomics
Bachelor of Science and Agricultural Economics
Submitted by:
Joriz Klenz Sabete,
Ma. Belinda De Chavez
Mary Joy Palaa
Submitted to:
Prof. Silverio V. Magallon Jr.
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Macroeconomic Determinants ofBanks Lending Rate in the Philippines
By: Joriz Klenz Sabete, Ma. Belinda De Chavez and Mary Joy Palaa
I- IntroductionPrime rate is the term applied in many countries to reference interest rate used
by banks. It is the rate that commercial banks charge to its most creditworthy
customers (Wikipedia). The fund was a formed as an investment medium to participate
in bank loans from lending banks. These funds were a vehicle for banks to expand
their equity or reduce their outstanding loans (Peter De Lio).
The prime rate is the one of the most watch variables in the economy of any
particular country. It is an important index used by banks to set rates on many
consumer loan products, such as real estate, mortgage, credit cards, auto loans and
others. Hence, prime rate gone, credit card rate will soon follow.
The fluctuations of prime rate or banks lending rate are influenced by varieties
of economic factors such as direct and indirect factor and it is a simple matter of
Federal Reserve decisions. Its fluctuations are reflecting in the supply of funds,
available for loans from lenders, and the demand, from barrowers. If the demand for
borrowing is higher than the funds they have available, they can raise their rates or
borrow money from other people by issuing bonds to institutions in the wholesale
market. The trouble is the source of funds is more expensive. Therefore interest rates
go up. If the banks and trust companies have lots of money to lend the consumer will
get special rate discounts and the lenders will be very competitive, keeping rates low 1.
The Philippine lending rates fluctuations result to swift decision concerning the
status of a country. Banko Sentral ng Pilipinas (BSP) lending rate increased seasonally
to 3.2 percent from 2.8 percent as inflation continued to decline while prime rate was
1The Financial Pipeline (http://www.finpipe.com/interest.htm).
http://www.finpipe.com/interest.htmhttp://www.finpipe.com/interest.htmhttp://www.finpipe.com/interest.htmhttp://www.finpipe.com/interest.htm -
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on the rise (Chipongian, 2010)2. But eased by 2011 to 2 percent in the third quarter
from 2.5 percent in the second quarter due to reduction in the average nominal bank
lending rate while inflation remained steady (Agcaoili, 2011)3. As well as,
unemployment and rising and falling of prices attributes to the swift decision related
to economic difficulties which contributes to the fluctuation of banks lending rates.
Consequently, this case must be pursued by an immense study too satisfy the
concerns of the economy and the people lying on it.
Objective
The focal point in this study is to determine the effects money supply, to the
occurring fluctuation of banks lending rate. Specifically, this aims to:
To present the trend across time of the variables used, which are:o Banks Lending Rateso Money Supply
Determine the correlation of money supply to interest rate.Scope and Limitation
The study focuses on the effects of the given indicator money supply to banks
lending rate as the predicted variable. The data drawn in this study was a time series
data from 1980-2010 taken from the Philippine statistics. The researcher uses
Ordinary Least Square (OLS) to minimize the sum of Residual Square with correlation
approach. Through this, the behavior of the interest rate in response to the changes
occur by the given variable will be realized.
2Manila Bulletin Publishing Corporation (http://www.mb.com.ph/articles/268064/banks-real-lending-
rate-rising-trend).3 Philstar (http://beta2.philstar.com/business/744951/101258/prime-bank-now-under-receivership).
http://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trendhttp://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trendhttp://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trendhttp://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trendhttp://beta2.philstar.com/business/744951/101258/prime-bank-now-under-receivershiphttp://beta2.philstar.com/business/744951/101258/prime-bank-now-under-receivershiphttp://beta2.philstar.com/business/744951/101258/prime-bank-now-under-receivershiphttp://beta2.philstar.com/business/744951/101258/prime-bank-now-under-receivershiphttp://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trendhttp://www.mb.com.ph/articles/268064/banks-real-lending-rate-rising-trend -
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II- Literature Review and Analytical Framework
Theory Base
Base in the Keynesian Theory of liquidity preference framework developed by
John Maynard Keynes determines that the equilibrium or change in the interest rates
depends on the supply and demand for money.
The liquidity preference framework suggests that money supply has a negative
relationship to interest rate. As money supply increases, interest rate decreases with
the same level of money demanded. This aims to increase the aggregate output
(Lombra, 2000). In lowering interest rate more investors will encourage to invest, so
the demand for labor increases. In increase in investment aggregate expenditure
increases and in increase in aggregate expenditure, aggregate output will rise, under
the concept of Aggregate Demand in the Goods and Money Market (Case et al., 2000).
In a basic supply and demand application, given a constant demand for money,
increasing the money supply will invariably lower interest rates because of the
availability of money, more money around means its easy to get and will thus
(borrowers can) command lower interest rates.
Related Studies
There were established studies related in interest rate or banks lending rate.
This could be utilized as references or bases to satisfy the given theory and to expand
the study.
Interest rates movement is given a lot of attention by public because it serves
as a stimulant of when was the right time to go on banks. Fluctuation in the banks
lending rate could positively or negatively affect a particular economy as well as
individuals wealth and debt. It is influence by personal decisions or whether to
consume or to save. Moreover, the prime rate also affects the decision of business
(Angie Arias, pdf, 2005).
Base on the study of Felicia Omowunmi Olokoyo in 1 percent increase of money
supply correspond 0.4 percent reduction to bank lending rate. She found out that due
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to macroeconomic instability changes in money supply has a negative long-run impact
on the lending bank rate in Nigeria. Specifically, banks tend to reduce lending during
periods of high liquidity basically because of possible low return on lending (and
possibly low loan demand) and perhaps have to channel their funds towards
alternative sources of income earning activities and investments.
Furthermore, in the study of Madjed Bader et al. (2010), they found out that
increasing money supply reduces banks lending rate or interest rate and allows
investment to increase. As well as Raj Chetty (2007) found out that in increase in
interest rate causes a reduction on interest rate. Moreover, base on the study of James
E. Gunderson et al. (2007), in rise in interest rate reduces investment that results to
low economic activity then demand for labor in the goods market decreases.
Hence, the related studies on this research support the conceptualization on
this research.
Analytical Framework
This pertains on how money supply affects banks lending ratesfluctuation.
Figure 1. The Conceptual Framework of the Study
Null hypothesis:
Ho1: : Money Supply has no significant relationship to interest rate.
INTEREST
RATE
Money Supply
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III- MethodologyThis study uses correlation analysis to determine the impact of money supply to
interest rate.
Research Design
This research is a causal study which uses time series data analysis of the year
1980-2010. Which tend to explain the effects of investment, price, money supply, and
unemployment rate to banks lending rate and the response of it.
Variable Measurement
Variable Unit Definition
Interest Rate -Percentage -It is also called bankslending rate.
-The interest rate charged by
banks on loans to prime
customers.
Money Supply -Percentage -Money and quasi money
comprise the sum of currency
outside banks, demand
deposits other than those of
the central government, and
the time, savings, and foreign
currency deposits of residentsectors other than the central
government. This definition of
money supply is frequently
called M2.
-it is the percentage annual
growth of money supply.
Source of Data
The data was taken from World Bank4 from year 1981-2010 which are interest rate
and money supply.
4 http://data.worldbank.org/country/philippines
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IV- Result and DiscussionIn this part shows the result and the discussion of the given objectives.
I. Trend Presentation of Macroeconomic VariableIn this section the trend of the different macroeconomic variables are being
presented and interpreted.
Banks Lending Rate
It can be seen from the graph that the trend of banks lending rate is decreasing
from 1980 to 2010. This due increasing investment and money supply. Moreover, it
has the highest lending rate during 1985 with 28.61% and the lowest lending rate
during 2009 with 8.57% because Philippines has decided to cut its interest rate by 25basis points ensure liquidity and boost market confidence amid the global economic
crisis, the Bangko Sentral ng Pilipinas affirmed5.
Source: World Bank, 2012
Figure I- Trend for Banks Lending Rate
5Updated March 05, 2009, 05:30 PM.
Philstar.com.http://www.philstar.com/Article.aspx?articleid=445785
0
5
10
15
20
25
30
35
1975 1980 1985 1990 1995 2000 2005 2010 2015
InterestR
ate
Year
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Trend in Money Supply
Money is used in virtually all economic transactions; it has a powerful effect on
economic activity. In figure 1, it shows the fluctuating trend of money supply in the
Philippines. Philippines experience the maximum of percentage increase money during
1998 with 59.53% and minimum 21.97% in 1980. The cause for an increase of money
supply works both through lowering interest rate which spurs or stimulate
investment, and through putting more money in hands of consumers and vice versa.
During 1980, the economy began to run into difficultly because of the declining
world market for the Philippines exports. It is the under of Pres. Marcos regime and
revive during 1986 in the time of Pres. Corazon Aquino. But in 1988 the economy
again began to encounter difficulties. The trade deficit and the government budget
deficit were a particular concern. But increase the supply of money until 1990 until it
reaches to the peak in the year 1998. Due to rapid developing of subsector that
increases the GNP through the introduced new technologies6.
After the peak on 1998 it comes down to recession to 2006 and rise again until
2010.
Source: World Bank, 2012
Figure II- Trend of Money Supply
6Taken fromhttp://www.economy.com/home/products/databases.asp.
0
10
20
30
40
50
60
70
1975 1980 1985 1990 1995 2000 2005 2010 2015
MoneySupply
Year
http://www.economy.com/home/products/databases.asphttp://www.economy.com/home/products/databases.asphttp://www.economy.com/home/products/databases.asphttp://www.economy.com/home/products/databases.asp -
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II. Correlation of Money Supply to Banks Lending RateBase on the correlation matrix, it shows that money supply has a negative
relationship to interest rate. Thus, 66% can be explained of money supply to interest
rate with the .000 significance level. Hence, there are highly correlated.
Paired Correlation
Correlation Significance
INTEREST and MONEYSUPPLY
-.665 .000
V. ConclusionBase on the analysis in the correlation the null hypothesis is being rejected. It
implies that money supply and interest rate has a negative relationship. Money supply
could explain 66% to interest rate. Thus there are highly correlated.
As a final point, as money supply increases, interest rate decreases. This
encourages investors to invest that aims to increase aggregate output and the right
time to lend in banks.
I. Policy RecommendationTo redress the prevailing situation, this study drawn to these recommendations:
Strict implementation of tight monetary fiscal policy to increase moneysupply that aims to decrease interest rate.
Decrease interest rate to encourage investments that to increase theaggregate output in the economy.
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Appendix I
Paired Correlation
N Correlation Significance
Pair 1 INTERESTandMONEYSUPPLY
31 -.665 .000
Descriptive Statistics
N Minimum Maximum MeanStd.
Deviation Variance
INTEREST 31 8.57 28.61 15.0643 5.54725 30.772
MONEYS 31 21.97 59.53 42.0289 13.60293 185.040
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Appendix II
Data in the Model
Obs. Interest Rate Money Supply
1980 14.00 21.97
1981 15.34 22.61
1982 18.12 23.68
1983 19.24 27.92
1984 28.20 25.90
1985 28.61 27.31
1986 17.53 27.38
1987 13.34 26.06
1988 15.92 26.23
1989 19.27 28.79
1990 24.12 31.11
1991 23.07 32.18
1992 19.48 34.24
1993 14.68 38.00
1994 15.06 42.15
1995 14.68 46.85
1996 14.84 50.90
1997 16.28 56.21
1998 16.78 58.90
1999 11.78 59.53
2000 10.91 59.25
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2001 12.40 57.89
2002 9.14 56.77
2003 9.47 55.70
2004 10.08 52.71
2005 10.18 50.99
2006 9.78 52.10
2007 8.69 52.87
2008 8.75 51.99
2009 8.57 52.32
2010 8.70 52.39
Note: Highlighted figures are forecasted data.
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