Credit Channel

7 Key excerpts on "Credit Channel"

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  eBook - ePub

  Routledge Handbook of the Economics of European Integration

  • Harald Badinger, Volker Nitsch, Harald Badinger, Volker Nitsch(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  9 The Credit Channel of monetary policy in the euro area

  Angela Maddaloni and José-Luis Peydró1

  DOI: 10.4324/9781315796918-12

  1 Introduction

  The credit provided by banks is key to fund investment and consumption. In the euro area this is particularly true since bank loans represent the large majority of the credit going to the non-financial sector (corporates and households).2 How credit provision responds to monetary policy impulses is therefore a crucial question which policy makers are generally confronted with, in particular when a financial crisis strikes.

  The theory of the Credit Channel of monetary policy, as defined by Bernanke and Gertler (1995 ), states that monetary policy (via monetary rates, reserve requirements but also quantitative easing) affects GDP and prices through credit. Both demand and supply of credit respond to monetary policy impulses, to different degrees, depending on the economic cycle (good or crisis times), on the type of loan and on the identity of the borrower (households, firms and banks).

  Figure 9.1 reports a schematic representation of how monetary channels may affect the economy through credit (see ECB, 2011 , p. 59, for all the transmission channels of monetary policy). The traditional “cost-of-capital” channel determines the demand for credit from firms and households, by determining the level of market interest rates and borrowing rates. The broad Credit Channel (as defined by Bernanke and Gertler, 1995

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  eBook - ePub

  The Handbook of China's Financial System

  • Marlene Amstad, Guofeng Sun, Wei Xiong(Authors)
  • 2020(Publication Date)
  • Princeton University Press

    (Publisher)

  balance-sheet channel (broad Credit Channel). The bank lending channel is based on the view that banks have a special role in the financial markets, because they are well suited to deal with asymmetric information problems in the credit market (Mishkin, 1996; Kashyap and Stein, 2000). The balance-sheet channel assumes that changes in the external finance premium amplify the direct effects of monetary policy on interest rates (Bernanke and Gertler, 1995).

  4.2. Empirical Assessment of the Chinese Case

  The functioning of the transmission channels discussed above is summarized mainly from the viewpoint of experiences in the advanced market economies. But as we speculated earlier, the special transition features of the Chinese economy may affect the transmission mechanisms of the monetary policy. Here we attempt to depict the way the transmission channels work by reviewing the related empirical literature. While the empirical analyses reveal quite mixed findings on almost all fronts, the general patterns are that the interest rate channel was quite weak in the earlier years but grew much stronger in recent years; that the Credit Channel is quite effective, relatively speaking; that functioning of the wealth channel is unclear, as monetary policy has distinct effects on asset prices but asset prices do not have stable impacts on consumption; and that the exchange rate channel is also not stable.

  In advanced market economies, interest rates are probably the most important parameters for monetary policy and financial markets. Central banks often choose short-term market interest rates as either policy tools or operational targets. In China, however, the PBC does not directly adjust or target at the short-term market rates, although it started to pay greater attention to those rates in recent years. Early economic studies find interest rates having a modest role in the Chinese economy and a weak linkage between interest rates and real sector activities. For instance, studies by Laurens and Maino (2007) and Koivu (2009) confirm that the interest rate channel does not function properly. Possible explanations for this phenomenon include the repressive financial policies: Banks’ credit allocation favors large SOEs, which still exhibit certain degrees of “soft budget constraint.” The main borrowers are less sensitive to changes in interest rates, while the interest rate sensitive sectors, such as private firms, are either discriminated against or altogether excluded from formal financial services.

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  Islamic Monetary Economics

  Finance and Banking in Contemporary Muslim Economies

  • Zeyneb Hafsa Orhan, Taha Eğri(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  By reviewing the theoretical literature, we find that the traditional monetary policy theories have mainly emphasized the control of money supply to make changes in the interest rate and levels of spending in the economy (Friedman and Schwartz, 1963; King and Plosser, 1984; Sim, 1992), although the importance of financial intermediaries, particularly banks, is highly highlighted by new theories of monetary policy (Bernanke and Gertler, 1995). The role of the banking sector in the monetary policy transmission process depends on how much banks rely on deposits, how much consumers and business firms are bank dependent, and how much bank credit expansion is affected by monetary policy shocks.

  Mishkin (1996) is the first one who seems to be dissatisfied with the performance of conventional interest rate channels and, perhaps for the first time, systematically introduced the role of asymmetric information in financial markets, which led to the Credit Channel in two different ways in credit markets. The first one is the balance sheet channel, and the second one is the bank-lending channel, which is also known as the credit supply channel of banks. By reviewing a vast amount of empirical literature, we find that several well-known scholars have provided strong evidence confirming the transmission process of monetary policy through these two channels for different economies across the globe. Examples of these researchers include, among several others, Kashyap and Stein (1994), Bernanke and Gertler (1995), and Cecchetti (1999).

  After the 2007–08 financial crisis, the credit supply channel of banks, which is known as the “bank-centric view of monetary transmission”, came to the forefront because the banking sector was affected badly. According to the bank-centric view of monetary policy transmission mechanism, money, bonds, and bank loans are assumed to be three important financial assets in the economy. The functioning of the credit supply channel of monetary transmission mechanism mainly relies on the assumption that during periods of monetary tightening policy, the aggregate lending by banks slows down, and non-banking financing such as commercial papers increases. A monetary tightening drains reserves from the banking sector, which in turn weakens banks’ deposit base. Hence, banks are expected to be unable to issue new loans and even perhaps to continue with their existing lending projects without using external sources of finance such as equity, debt, or commercial paper issuance (Gertler and Gilchrist, 1993; Kashyap and Stein, 1994; Cecchetti, 1999).

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  Developing Sustainable Balance of Payments in Small Countries

  Lessons from Macroeconomic Deadlock in Jamaica

  • Andre Haughton(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  In recent years, commercial banks’ lending channels have been said to be more relevant to developing countries based on the premise that investments are mostly financed by banks where changes in monetary policy affect the supply of loans directly. According to Ramey (1993), there are two key conditions that must be satisfied before a lending channel can be made operational. First, banks must not be able to shield their loan portfolio from changes in monetary policy and second, borrowers must not be able to fully insulate their real spending from changes in the availability of bank credit. In light of this, Gambacorta (2001) also highlighted the implication of this mechanism on the real economy by drawing attention to the fact that monetary tighten- ing will cause overall investment and thus productivity and consumption to decline. A study by Urquhart (2006) examined the bank lending channel to the conduct of monetary policy in Jamaica and how individual bank lending characteristics affect the efficacy of this channel. Monthly bank balance sheet data panel were used along with macroeconomic data spanning January 2000 to December 2005. The Arellano and Bond (1991) Generalized Method of Movements (GMM) approach was used to estimate a model of the banking lending channel of monetary transmission. The hypotheses examined in this study were: (1) smaller banks are most affected by changes in monetary policy; (2) less liquid banks are impacted more greatly by monetary shocks; and (3) less capi- talized banks experience greater changes in the amount of loans that they offer given a change in monetary policy. The findings illustrated that the bank lending channel exists as tightening monetary policy lead to a 152 9 COMMERCIAL BANKS AND THE MONETARY TRANSMISSION MECHANISM reduction in the loan portfolio. In addition, the results also inferred that the characteristic size, liquidity and capitalization played a major role in the efficacy of the transmission process.

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  eBook - ePub

  Regional Monetary Policy

  • Carlos Javier Rodriguez Fuentes(Author)
  • 2005(Publication Date)
  • Routledge

    (Publisher)

  16

  The new Keynesians have also paid attention to the role of credit in the transmission mechanism of monetary policy. This literature is usually known as the lending or credit view and, contrary to the traditional ‘money view’ that sees monetary policy operating exclusively only through changes in interest rates, it maintains that monetary policy might make access to credit more difficult or expensive for some borrowers when there exist credit market imperfections.17 According to this view, monetary policy ‘…will affect the level of investment, not through the interest-rate mechanism, but rather through the availability of credit’ (Stiglitz and Weiss 1981:409). Consequently, the transmission mechanism implicit in the textbook IS-LM model is rejected, since it does not take into account such capital market imperfections.18

  The assumption that capital markets are imperfect leads to the inclusion of two additional channels in the transmission of the monetary policy, namely the balance sheet channel and the lending channel (Bernanke and Gertler 1995). A large amount of empirical evidence exists which supports the relevance of these two original channels,19 and could be complemented with the much more recent ‘capital channel’ (Van den Heuvel 2002a, 2002b).

  This literature is concerned with the existence of credit rationing when capital markets fail to work properly. It is therefore when capital markets are incomplete that the banking system becomes important for the transmission of the monetary policy, due to several factors. From the bank lending channel perspective, monetary policy may affect credit availability to some kinds of borrowers (those most dependent on banks) when banks do not have close substitutes for bank loans in the asset side of the bank’s balance sheet. On the other hand, the ‘balance sheet channel’ (also known as the financial accelerator) might reinforce monetary policy through their effects on the financial structure of economic agents. Finally, the ‘bank capital channel’ suggests that monetary policy might also influence lending through its impact on bank equity capital (Van den Heuvel 2002a, 2002b). Overall, what this literature suggests is that banks are important for the ‘transmission mechanism’ of the monetary policy because they provide credit and monetary policy affects credit availability when capital markets are imperfect.

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  Risk Management Post Financial Crisis

  A Period of Monetary Easing

  • Jonathan A. Batten, Niklas F. Wagner, Jonathan A. Batten, Niklas F. Wagner(Authors)
  • 2014(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  The insig-nificance of credit to the private sector suggests that the importance attached to the bank lending channel in previous studies is waning while the marginal significance of the stock market indicator signals the potential for asset price channel. The study also shows that the interest rate and exchange rate channels of monetary policy transmission are relatively more important while the bank lending and asset price channels of monetary pol-icy transmission are relatively weak in Kenya. The variance decomposition results show that within 12 months, a monetary policy shock explain 35 percent of variations in lending interest rate, 16 percent of variations in the exchange rate, 3 percent in the stock market indicators, and 1.6 percent of the variations in credit to the private sector. However, transmission of monetary policy to the ultimate objectives, mainly inflation in this case, is somewhat slow, with about 14 percent of the variations in overall 360 ROSELINE NYAKERARIO MISATI ET AL. consumer price indices being explained within 12 months but it is signifi-cantly slow to output, with only 1.6 percent of the variations in GDP explained by interbank shocks. These results imply that, first, the central bank can somewhat rely on the interest rate and exchange rate channels in its pursuit of price stability objective. This observation does not however imply that the retail interest rate rigidities observed in practice, especially following a monetary policy loosening have disappeared. Further work on interest rate asymmetries, demarcating different monetary policy regimes, if possible, is critical to authoritatively validate the role of interest rate channel of monetary trans-mission. Second, the significantly slow and weak transmission of monetary policy actions to economic growth suggests a limited role of monetary pol-icy on growth and thus questions the wisdom of pursuing multiple objec-tives.

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  Monetary Economics

  Theories, Evidence and Policy

  • David G. Pierce, Peter J. Tysome(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  If it is link (a) which breaks down it does not automatically follow that the 'intermediating' variable (wealth, credit availability, etc.) is irrelevant to an explanation of the behaviour of economic activity. For example, the Unk between money supply and the availability of credit may be very tenuous, yet credit may contribute very significantly to the determination of prices, output and employment. In this situation, policy should be directly focused on credit; in this way we can conveniently distinguish 'credit' from monetary policy. If it is link (b) which breaks down we shall say that the particular monetary transmission mechanism is of no 'operational significance' as far as the goal variables of the economy are concerned. We should also distinguish between a 22 The portfoUo balance transmission mechanism 23 monetary transmission mechanism and a channel of monetary influence. The monetary transmission mechanism refers to the general conceptual framework within which the analysis of monetary disturbances may be undertaken, whereas the channel of monetary influence refers to the route through which these monetary disturbances influence the goal variables. It is possible for there to exist a number of channels of monetary influence within the context of the same monetary transmission mechanism. This will become more apparent as we proceed. The portfolio balance transmission mechanism Link (a): money and portfoUo balance A portfoHo, loosely defined, is an array of assets and debts of differing yields, risks, maturities and other characteristics. Portfolio management theory is concerned with providing explanations of the behaviour of individual and economy-wide portfolios. Portfolio balance theory contends that the composition of a portfolio will depend upon the characteristics of assets (and debts) - primarily yield, risk and maturity -as well as wealth-holders' preferences.

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