Abstract
We empirically analyze how bank lending reacts to monetary policy in the presence of global financial flows. Employing a unique and novel dataset of the funding modes and currency composition of the full population of Norwegian banks in structurally identified regressions, we show that the efficiency of the bank lending channel is affected when banks can shift to international funding and thus insulate their costs of funding from domestic monetary policy. We isolate the effect of global factors from domestic monetary policy by focusing on the deviation of exchange rates from the prediction of (uncovered and covered) interest rate parity. The Norwegian banking sector represents an ideal laboratory since the exogenous exchange rate dynamics allows for a convincing identification of the relation between lending and global factors.
Highlights
How does bank lending react to monetary policy in the presence of global financial flows? As the so-called “bank lending channel” in conventional wisdom states, tightening domestic monetary policy raises banks’ funding costs in the domestic money market, which leads to a contraction in banks’ credit supply, and vice versa (see, for example, Kashyap and Stein (2000))
This costs advantage represents the interest rate differential between Norway and the core economy that is orthogonal with regard to domestic monetary policy and contingent on exchange rate dynamics
We provide the first micro-level evidence on how banks’ global funding limits the bank lending channel of domestic monetary policy transmission in a small open economy, as well as how such global financial flows modify banks’ balance sheets and affect their risk-taking behavior
Summary
How does bank lending react to monetary policy in the presence of global financial flows? As the so-called “bank lending channel” in conventional wisdom states, tightening domestic monetary policy raises banks’ funding costs in the domestic money market, which leads to a contraction in banks’ credit supply, and vice versa (see, for example, Kashyap and Stein (2000)). We conjecture that the failure to document a classic bank lending channel for Norway after 2001 is due to the omission of potential changes in funding costs for Norwegian banks in international money markets To overcome this omission, we integrate global funding conditions as shaped by the interaction between foreign monetary policy and exchange rate dynamics into the empirical model. Our main contribution is to provide the first microeconometric, bank-level evidence on the risk-taking channel of currency appreciation, as proposed by Bruno and Shin (2015a) This evidence highlights the role of international spillovers of monetary policy and illustrates the need to account for currency exchange dynamics, when exploring the interactions between domestic and foreign monetary policy.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
