Are asset quality weaknesses holding back bank lending? Evidence from MENA region

Abstract

ABSTRACT The role of asset quality in impacting bank lending has been examined in several studies. What has however not been examined is how asset quality interacts with monetary policy to influence bank lending or what is popularly referred to as the asset quality channel of monetary transmission. Employing data during 2011–2020, we examine whether there exists an asset quality channel of monetary transmission for MENA country-banks. The findings provide strong support in favour of an asset quality channel of monetary transmission. In particular, the baseline results suggest that a one percentage point increase in the impairment ratio leads to a decline in bank lending by 11%. These findings differ across key bank characteristics such as profitability, capital and funding costs for conventional versus Islamic banks. Relatedly, macroprudential policies play an important role in arresting asset quality deterioration.