Abstract
The study provides an analysis of the relationships between monetary policy, shadow banking and bank liquidity in emerging market economies. It is aimed at broadening knowledge on the effect of shadow banking on monetary policy transmission. Furthermore, the study seeks to analyze the impact of changes in bank liquidity on the growth of the shadow banking sector. We employ panel VAR technique to analyse the dynamics of monetary policy, shadow banking and bank liquidity using data for 15 emerging economy countries. A contractionary monetary policy shock results in a decrease in shadow banking and a decrease in bank liquidity. We also find that a positive shock in bank liquidity increases shadow bank growth and a positive shock in shadow banking also increases bank liquidity. The results point to complementarity between shadow banking and bank liquidity; and the interconnectedness between the two markets in emerging economies. We suggest continuous monitoring of shadow banking activities to minimize transmission of risk from the shadow banking system into the banking sector.
Highlights
The shadow banking1 sector accelerated growth in advanced economies in the period prior to the financial crisis and its negative role in propagating systemic risk is well documented (Adrian and Ashcraft, 2016, FSB, 2017)
It is noteworthy to mention that variables used in the estimation are logarithms in the cases of inflation, gdpn, reer, shadow banking and liquidity is the logarithm of M1 or M2 depending on available country data
The results indicate a weak response of monetary policy to developments in the shadow banking sector
Summary
The shadow banking sector accelerated growth in advanced economies in the period prior to the financial crisis and its negative role in propagating systemic risk is well documented (Adrian and Ashcraft, 2016, FSB, 2017). Whilst there is no debate on the existence of this sector and the role played by shadow banks, it is not clear as yet how its growth impacts monetary policy transmission. With the continued growth of shadow banking assets in both advanced and emerging economies, it is ideal to analyse the possible impact this has on monetary policy transmission to proffer new ideas on how to improve monetary policy frameworks in different countries. The purpose of our paper is to empirically analyse the linkages between shadow banking and monetary policy within the context of emerging economies. Contributions made in this direction range from studies that analyse the association between price stability and financial stability (Smets, 2014, Hellwig, 2015), papers on effectiveness of monetary policy that accounts for shadow bank activities (Ge, 2011, Verona et al, 2013) and studies that directly investigate linkages between shadow banking and monetary policy (Chen et al, 2017, Nelson et al, 2018, Verona et al, 2013, Xiang and Qianglong, 2014)
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