Does bank competition matter for the effects of macroprudential policy on the procyclicality of lending?

Abstract

Competition is an inherent and natural environment in which banks operate and extend loans. Despite the extensive debate on the impact of bank competition on risk-taking and procyclicality, there is no evidence of its role in the effects of macroprudential policy on loan growth and on the sensitivity of lending to the business cycle. Using over 80,000 bank-level observations in 95 countries from 2004 to 2015, we find that increased competition strengthens the countercyclical effects of macroprudential policy instruments (MPIs) in terms of reduced loan growth. Bank lending is procyclical in a perfectly competitive industry. However, any decrease in the intensity of competition in countries not applying MPIs is related to the increased procyclicality of lending. The sensitivity of lending to the business cycle in countries implementing macroprudential policy depends on the type of MPI and the length of use of the instruments. We demonstrate that an extended duration of use of cyclical instruments is associated with increased procyclicality in lending. In a perfectly competitive environment, we find increased procyclicality of credit in countries using cyclical instruments for longer periods, and decreased procyclicality of credit in countries applying balance-sheet-oriented instruments. Under the imperfectly competitive banking sector, we find the opposite effects of macroprudential instruments on the procyclicality of credit.