Academic journal article Economic Inquiry

Differential Deposit Guarantees and the Effect of Monetary Policy on Bank Lending

Academic journal article Economic Inquiry

Differential Deposit Guarantees and the Effect of Monetary Policy on Bank Lending

Article excerpt


The bank-lending channel (BLC) emphasizes the role of bank loans in the transmission of monetary policy. According to the BLC, contractionary monetary policy can decrease the loan supply of banks that face informational constraints. Additionally, some of the borrowers of these banks are bank dependent, so that a fall in loan supply decreases the expenditures of these customers. This channel complements the usual interest rate/money channel by offering an explanation for why contractionary policy has severe effects on the economy. It also implies that policy has distributional effects across banks and their customers.

Evidence of a BLC is gleaned from the cross-sectional asymmetric loan responses of constrained versus unconstrained banks. Empirical studies usually approach the identification of the BLC by dividing banks using balance sheet constraints. This approach implicitly assumes that bank balance sheet structure is independent of monetary policy. However, because bank balance sheet constraints can be influenced indirectly by the effects of policy on the behavior of bank customers, it is not clear whether these studies are measuring shifts in loan supply or loan demand.

This paper identifies a BLC utilizing data on a banking system where de jure deposit guarantees were differentially applied. From 1995 until 1999, the Polish government granted full guarantees to one group of banks, while the others had only a partial guarantee. A full guarantee could give banks an advantage in raising nonreservable, uninsured funds, allowing these banks to circumvent contractionary monetary policy by continuing loan growth. Conversely, the loans of banks with only partial guarantees should decrease due to the inability of these banks to raise alternative funds during contractionary policy. The existence and extent of a BLC are measured in this paper by testing for a differential loan growth response between these two groups of banks. Additionally, we test for the disappearance of this differential response in the post-1999 period when the full guarantee was eliminated and reserve requirements on all deposits were equalized. Unlike the use of balance sheet constraints to distinguish a BLC, the use of this double difference across banks and over time is an innovation that should mitigate most concerns about identification.

This approach identifies a BLC that may have widespread applicability and has implications for financial system development. Policies that establish differential guarantees are common in emerging financial markets. Banks that are given full guarantees are often those that dominate the banking system and are the most inefficient. Our BLC implies that central banks may have trouble controlling the credit growth of the fully guaranteed banks. Additionally, the adverse effect of policy attempts to limit credit growth will fall disproportionately on the partially guaranteed banks, which are often the most efficient banks. This distributional effect of policy could hamper financial system development.

The next section reviews the literature on the BLC and differentially applied deposit guarantees. Section III gives an overview of the Polish banking system focused on deposit guarantees, loan growth, and monetary policy. Section IV explains the data and specifies the empirical model used to test our loan growth and time deposit funding hypotheses. This section also presents the empirical results. The final section lays out some implications following from the results.


A. The BLC

In the BLC, contractionary monetary policy pulls away required reserves, forcing banks to reduce reservable deposit funding for their loans. Banks try substituting into large time deposits because of the lower reserve requirements and greater interest sensitivity. Due to informational frictions and the resulting risk of default associated with these uninsured deposits, depositors require a risk premium. …

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