A Two-tier Model of Canadian Chartered Bank Rate-setting Behaviour and the Implications for Identifying Demand for Loans and Deposits Equations

Abstract

<p>In this thesis deposit and loan rate-setting equations for chartered banks are derived on the premise that these rates are set so as to maximize the banking industry's profits. Because of the oligopolistic nature of the Canadian banking industry and because explicit collusion is illegal an optimizing model of chartered bank ratesetting behaviour was integrated into the institutional framework of the Canadian banking industry.</p> <p>To do this a two-stage model of the Canadian banking industry is proposed. At the first stage, the prime rate on loans and the rate on non-chequing personal savings deposits are set so as to maximize the collective profits of the industry. To circumvent the illegality of explicit collusion a price leadership model is developed. In this model it is not one of the individual banks which is a price leader, but rather changes in the bank rate act as a signal for all of the individual banks to change their rates. The formulation proposed was tested and the hypothesis accepted for both rates. The second stage of the two-stage model is concerned with asset and liability management and is not developed in this thesis.</p> <p>A second contribution of this thesis is to take into account chartered bank rate-setting behaviour when estimating demand equations for both business loans and nonchequing personal savings deposits. When the estimation procedure used reflects these problems it is found that there are large changes in the values of the estimated coefficients in the demand functions for loans and deposits, compared to the simple O.L.S. estimates of the parameter values.</p>