‘Rate cuts have limited impact on credit growth’

MANILA, Philippines — While raising interest rates effectively tightens credit conditions and slows economic activity, lowering rates does not necessarily boost lending, according to the Bangko Sentral ng Pilipinas (BSP) Research Academy.

BSP Research Academy principal researcher Carolina Escranda and BSP Department of Economic Research bank officer V Bernadette Marie Bondoc-Quiban said the impact of monetary policy on banks’ lending activity is asymmetric, with evidence of transmission during restrictive periods but not during accommodative ones.

“Central banks can ‘pull’ back economic activity by raising interest rates, but they cannot ‘push’ it forward simply by lowering rates,” Escranda and Quiban said.

They said that during restrictive periods, higher interest rates increase borrowing costs, reducing loan demand and tightening credit supply.

However, lowering interest rates may not be enough to boost lending. “Banks may be reluctant to lend due to heightened perceptions of borrower risk or diminished profitability. Borrowers may also be unwilling to take on new debt amid economic uncertainty,” Escranda and Quiban said.

The BSP discussion paper identifies three key reasons for this asymmetry. First, while banks generally pass on interest rate increases to borrowers, banks also limit their interest rate hikes to avoid defaults.

During restrictive monetary policy periods, banks ration credit instead of fully passing on higher rates, leading to tighter lending conditions. But this is not the case for accommodative monetary policy.

“Lower interest rates do not necessarily result in increased borrowing if there is no demand for additional credit given economic conditions,” Escranda and Quiban said.

Second, businesses tend to adjust prices rather than output in expansionary periods, limiting the stimulative effect of lower interest rates.

Lastly, consumer and business sentiment plays a role as economic downturns generate more pessimism than booms create optimism, making expansionary policy less effective.

For the Philippines, the study noted that monetary tightening has a more pronounced effect on smaller financial institutions, while its influence on larger banks remains minimal.

“Therefore, if the BSP aims to influence aggregate credit growth, employing complementary tools targeting smaller banks could enhance monetary policy transmission, especially if the goal is to curb lending across the entire banking sector,” the authors said.

The BSP reduced interest rates by 25 basis points during its policy meeting last December, bringing the key rate down to 5.75 percent. The central bank has delivered a total of 75 bps rate cuts since August 2024.

Prior to the cuts, the BSP maintained borrowing rates for six consecutive meetings since November 2023.

From May 2022 to October 2023, the central bank had aggressively hiked by a total of 450 basis points to rein in inflation.