Aurora Borealis
25 July 2019 CFA Institute Journal Review

The International Bank Lending Channel of Monetary Policy Rates and QE: Credit Supply, Reach-for-Yield, and Real Effects (Digest summary)

  1. Michal Szudejko, CFA

Using Mexican supervisory data, the authors highlight the existence of the international risk-taking channel and spillovers of monetary shocks from “core countries” (such as the United States, the United Kingdom, and countries in the eurozone) onto emerging markets. This impact materializes during both softening and tightening of monetary policy. A softening monetary policy shock induces foreign banks to increase credit availability and risk taking, whereas a tightening shock is related to negative local firm real effects.

What Is the Investment Issue?

The authors examine the international credit and risk-taking channel of monetary policy using the example of Mexico. In particular, they analyze the effects of the following:

  • foreign monetary policy on the supply of credit from foreign banks to local companies;
  • foreign monetary policy shocks on real firm-level effects (another question here is, how can local companies mitigate the effects of such shocks?); and
  • expansive foreign monetary policy on the risk-taking channel of global banks.

Moreover, the authors verify whether the results of these phenomena depend on the type of monetary intervention used, such as the use of policy rates or asset purchases. The authors investigate potential differences in the way foreign and local banks accommodate local credit expansion.

How Did the Authors Conduct This Research?

The authors use data provided by the Mexican banking supervisor. The dataset consists of information on all business loans (including interest rates, absent from most credit registers around the world) from 2001–2015. The data include loans issued by banks from the “core” developed countries (such as the United States, the United Kingdom, and countries in the eurozone), which is particularly important because those loans constitute roughly 60% of all commercial bank credit in Mexico.

These records are matched with a firm’s balance sheet information and bank information on ownership and funding. The dataset has a monthly frequency. The authors use panel data regressions with diverse fixed effects chosen to capture specific behaviors. In particular, the authors use regressions at the loan-month and firm-bank-month levels to identify firms’ credit margins. They use regressions at the firm-year level to explore changes in firms’ real effects and frequency of credit substitutions. To capture real effects, the authors analyze total bank credit and firm-level credit availability as well as the dynamics of selected balance sheet items. This part of the research is crucial because the authors aim to show whether companies actively substitute bank credit extensions (global to local or local to global) that enable transmissions of adverse monetary policy stances.

What Are the Findings and Implications for Investors and Investment Professionals?

The authors’ key contribution is the identification of the international credit supply channel operating through foreign banks and its effect on risk taking and the real economy. Local credit supply and local firm-level real effects may be negatively affected by contractionary foreign monetary policy. Meanwhile, an expansive monetary policy may lead to greater risk-seeking or reach-for-yield behavior among banks and other financial institutions. Ultimately, the authors analyze the impact of monetary policy at the loan and firm levels. In this way, they are able to capture real effects.

A softening in foreign monetary policy increases the supply of credit provided by foreign banks to Mexican firms. All loan terms are affected, or extend, but the impact on the interest rate is relatively weaker. Importantly, the risk of future delinquencies also increases. The results seem to indicate that monetary policy shocks in core countries can have spillover effects in the emerging markets with real firm- and bank-level effects.

These results should be valuable to central bankers of both developed and emerging economies, those who study globalization and the interconnectedness of financial markets, and investors willing to better understand the risk associated with emerging market equity resulting from a core country’s monetary policy shock.

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