Considering the fact that monetary policy measures in the analyzed period were mainly conducted through changes of the main interest rate, it is important to explain some features of the interest rate transmission channel. The transmission mechanism of monetary policy through the interest rate channel has been traditionally very weak,<sup>11</sup> although some improvements in the more recent years of the transition period are notable. When analyzing the interest rate transmission channel, one should keep in mind that the banking system is in a position of excess liquidity: banks do not borrow from the central bank but invest in its short-term securities. In the past couple of years, banking competition has proven to be a very important factor in the banks’ interest rates, and it resulted in a declining trend of the lending interest rates—and in some years an increase in the deposit interest rates. The banks’ interest rate spread went down on average from around 6.0 percent in 2004, to around 4.0 percent in 2008, and to 2.4 percent in 2010 (Chart 10).

**Chart 10. Average lending and deposit-taking interest rates**

<!-- Start of picture text --> 25<br>20<br>15<br>10<br>5<br>0<br>Average lending interest rate on denar credits (in %, on annual basis)<br>Average interest rate on denar deposits (in %, on annual basis)<br>2002/01 2002/04 2002/07 2002/10 2003/01 2003/04 2003/07 2003/10 2004/01 2004/04 2004/07 2004/10 2005/01 2005/04 2005/07 2005/10 2006/01 2006/04 2006/07 2006/10 2007/01 2007/04 2007/07 2007/10 2008/01 2008/04 2008/07 2008/10 2009/01 2009/04 2009/07 2009/10 2010/01 2010/04 2010/07 2010/10 2011/01<br><!-- End of picture text --> Source: NBRM Historically, the pass-through effect seems to be stronger when there is a declining trend of the NBRM interest rate. The opposite direction of the main monetary policy rate, the increase in 2004, was not followed by the banks (see Chart 11). The downward trend of the banks' interest rates in 2004 was due mainly to the higher competitiveness in the banking system, the further enhancement of the banks' deposits, the improvement of the banks' credit portfolio quality, and higher efficiency in the banks' operation in that period. In 2008, monetary policy was tightening, the banks' lending interest rates remained almost unchanged, and the deposits interest rates were increasing in order to attract additional sources after low deposit growth at the initial stage of the world crisis. In 2009, the tightening of the monetary policy was only partially followed by the banks' interest rates. Like in 2008, the stronger reaction was again shown by the increase of deposit interest rates (by 1.2 percent) relative to the increase of the average lending interest rate (by 0.4 percent). In both years, the banks were reducing the interest rate spread,

> 11 Different analyses within the NBRM for different analyzed periods have shown that only 2 to 10 percent of the main monetary policy interest rate change was transmitted over average lending interest rates on the banks' denar credits, in the same month or with a one month time lag. The accommodation of the short-run dynamics of the banks' lending interest rates to their long-term equilibrium usually is slow.

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