Interest Rate Enigma: Cracking the Code in Pakistan's Retail Banking

Abstract

The mechanism of monetary policy transmission from policy rate changes to retail lending rates in Pakistan's banking sector is investigated in this article. Though monetary policy plays a major role in controlling overall demand, the results expose notable structural inefficiencies that compromise its efficiency. Based on Vector Auto regression (VAR) and impulse response functions (IRFs), empirical study reveals slow reaction. Low credit market competitiveness, high switching costs across deposit kinds, and credit rationing policies help to explain the slow change. Furthermore slowing down lending rate changes include asymmetric knowledge and poor corporate governance inside banks, therefore reducing the effect of policy changes on output growth and inflation control. The results imply that structural rigidity in the banking system could be more responsible for Pakistan's consistently high inflation than only transmission lags. The report emphasizes the need of banking sector changes, better financial market competitiveness, and tighter corporate governance consistent with central bank recommendations to increase the efficacy of monetary policy. Future studies will analyze the degree of sophistication of Pakistan's banking industry and investigate whether governance policies hinder the distribution of policy signals, therefore providing a complete knowledge of policy restrictions and possible remedial action.