Inside the bank lending channel

Abstract

This paper tests cross-sectional differences in the effectiveness of the bank lending channel. The results, derived from a comprehensive sample of Italian banks, suggest that heterogeneity in the monetary policy pass-through exists. After a monetary tightening the decrease in lending is lower for well-capitalized banks that are perceived as less risky by the market and are better able to raise uninsured deposits. Liquid banks can protect their loan portfolio against monetary tightening simply by drawing down cash and securities. The presence of internal capital markets in bank holding companies also contributes to insulate monetary shocks. Bank size is never relevant.

Introduction

The “bank lending channel” hypothesis postulates the existence of a channel of monetary policy transmission through bank credit. Such a channel is independent of the traditional “money channel”, which considers the effects of changes in the real interest rate on economic activity; it stems instead from financial market incompleteness and hinges upon imperfect substitutability between bank loans and privately-issued debt.

The effectiveness of this mechanism can vary between banks with different degrees of access to non-deposit funding. According to Kashyap and Stein (1995), the lending channel should be more important for small banks, which have a very simple capital structure and are financed almost exclusively with deposits and common equity. The impact of the “bank lending channel” should also be greater for banks with less liquid assets and less capital. Less liquid banks cannot protect their loan portfolio against monetary tightening simply by drawing down cash and securities (Kashyap and Stein, 2000, Kashyap et al., 2002, Stein, 1998); poorly capitalized banks have less access to markets for uninsured funding, so their lending is more dependent on monetary policy shocks (Peek and Rosengren, 1995, Kishan and Opiela, 2000, Van den Heuvel, 2001). All these studies on cross-sectional differences in the effectiveness of the “bank lending channel” refer to the US. The literature on European countries is instead far from conclusive (see Altunbas et al., 2002, Ehrmann et al., 2003).

European monetary integration has prompted interest in the study of differences in the “bank lending channel” among EU countries. In the spirit of Bernanke and Blinder (1988), heterogeneity in the structure of financial intermediation and in the degree and composition of firms' and households' debt could imply differences in the effectiveness of the monetary transmission mechanism in the euro area. If the countries that make up the Union have asymmetric bank lending channels, an active monetary policy that responds to information from financial indicators produces very great benefits; in this case, the optimal monetary policy is influenced not only by the magnitude of the variance of the shock but also by its point of origin, since its propagation within the union depends upon the characteristics of the country that has been hit by the disturbance (Gambacorta, 2002).

This paper presents three novelties with respect to the existing literature and in particular as regards the chapter for Italy in Angeloni et al. (2003). The first one is the use of a new data set of quarterly data for all Italian banks over the period 1986–2001 that: (i) includes a more refined measure of capitalization, the amount of capital that exceeds regulatory requirements, that is better able to capture the effects of capital constraints on lending supply; (ii) disentangles banks' funds in core deposits (insured debt) and CDs and deposits in bearer form (uninsured debt); this improves the understanding of the first step of the bank lending channel on deposits because distributional effects, if any, should be detected only with respect to funds that are not insured. The second novelty lies in a more comprehensive analysis of cross-sectional differences in the effectiveness of the “bank lending channel”. In particular, heterogeneity in the monetary policy pass-through is tested taking simultaneously into account not only the bank-specific characteristics of size, liquidity and capitalization, but also affiliation with a group, to capture the effects of internal capital markets in bank holding companies. The third novelty is a detailed comparison between results on the bank lending channel obtained using Supervisory reports data with those based on BankScope, a publicly available data set. In particular, I evaluate whether the annual frequency or the bias towards large banks in BankScope determine significant differences.

The results indicate the existence of shifts in deposits, lending and liquidity due to monetary policy action that are consistent with the existence of a “bank lending channel”. The effects of monetary policy differ among banks: after a tightening the decrease in total deposits is more pronounced for less capitalized banks that have a lower ability to raise uninsured form of funds. This result is significant at conventional values only when an excess capital indicator is used, instead of the standard capital-to-asset ratio, in order to capture the effect of the Basle capital requirements. As for lending, size does not affect the banks' reaction to a monetary policy impulse. This can be explained by a closer customer relationship, which provides an incentive for small banks, which are more liquid on average, to smooth the effects of a tightening on supplied credit. Liquidity is a significant factor enabling banks to attenuate the effect of a decrease in deposits on lending. The drop in liquidity following a monetary tightening is indeed greater for small and poorly capitalized banks. The presence of internal capital markets in bank holding companies also contributes to isolating exogenous variations in the financial constraints faced by subsidiary banks. Differences with respect to results obtained by other papers that use the BankScope data set are mainly due to a different quality of the data and to the treatment of mergers and acquisitions. On the contrary, the annual frequency is sufficient to capture heterogeneity in the adjustment of lending to monetary policy.

The remainder of the paper is organized as follows. Section 2 analyzes the problem of identifying the existence of a “bank lending channel” and Section 3 describes some institutional characteristics of the Italian economy. After a description of the econometric model and the data in Section 4, Section 5 presents evidence on the response of the main banks' balance-sheet items (loans, deposits and liquidity) to a monetary shock. Section 6 presents a comparison with the literature for Italy. The last section summarizes the main conclusions.