Deciphering the black-box of monetary policy transmission in South Asia

Abstract

Purpose ─ This study aims to identify the role of the bank capital channel by investigating how monetary policy affects bank lending through its influence on bank equity capital, in the transmission of monetary policy.Method ─ The study employs panel vector autoregression (pVAR) to investigate the complex relationship between monetary policy shocks, bank capital, and lending behavior. Results ─ The main findings are as follows: 1) The study finds evidence of both the bank lending and bank capital channels in South Asia. The analysis reveals a Granger causality between changes in bank capital position and policy rate adjustments, indicating a dynamic interplay between these variables. 2) The findings suggest, although direct effects of capital position changes on bank lending appear negligible, a nuanced examination uncovers the moderating influence of capital position changes on the impact of policy rate fluctuations on lending behavior. 3) The study suggests that healthier banking systems weaken the bank lending channel in South Asia.Implications/Significance ─ The study is significant because it sheds light on the mechanism involved in the interplay between monetary policy, bank capital, and lending, providing valuable insights for policymakers and future research directions.