Bank Market Power and Monetary Policy Transmission: Evidence from a Structural Estimation

We quantify the impact of bank market power on the pass-through of monetary policy to borrowers. To this end, we estimate a dynamic banking model in which monetary tightening increases banks' funding costs. Given their market power, banks optimally choose how much of a rate increase to pass on to borrowers. In the model, banks are subject to capital and reserve regulations, which also influence the degree of pass-through. Compared with the conventional regulation-based channels, we find that in the two most recent decades, bank market power explains a significant portion of monetary transmission. The quantitative effect is comparable in magnitude to the bank capital channel. In addition, the market power channel interacts with the bank capital channel, and this interaction can reverse the effect of monetary policy when the Federal Funds rate is low.