Abstract
This thesis examines the efficacy of the central bank’s policy rate pass-through to lending and deposit rates of banks in Pakistan, an emerging financial market. The thesis addresses three key research questions: (i) whether the pass-through differs across banks; (ii) whether it varies depending on the state of the economy; and (iii) whether it exhibits asymmetric behaviour in response to policy rate changes. Using a novel monthly bank-level dataset covering 18 years, this thesis employs three distinct econometric approaches tailored to the specific research questions. Chapter 1 applies a standard Autoregressive Distributed Lag (ARDL) model to estimate the size and speed of pass-through, examining variations across business cycle phases. Chapter 2 employs a two step Nonlinear ARDL (2SNARDL) model to capture asymmetric responses of retail rates to policy rate hikes versus cuts. Chapter 3 extends the analysis using a state-dependent Local Projections (LP) framework with instrumental variables to evaluate the response of retail rates to exogenous monetary policy shocks across economic states. The findings consistently indicate significant heterogeneity across banks. Pass-through is relatively complete for Islamic banks and lending rates respond more fully to rate increases than decreases, reflecting asymmetry. However, there is limited evidence of state-dependent effects, suggesting that macroeconomic conditions have a minor influence on transmission. Sensitivity analyses using alternative policy rate measures, state proxies, and lag structures confirm the robustness of these results. Overall, the thesis exhibits that bank-level characteristics including ownership, market concentration, and operational structure are key determinants of monetary policy effectiveness in Pakistan. The study contributes to the literature by providing the first comprehensive assessment of heterogeneity, asymmetry, and state-dependence in retail rate responses, offering important insights for policymakers seeking to enhance the effectiveness of monetary transmission in emerging, bank-dominated economies.