Puntaje por dimensiones

A recent issue of interest in central banking is whether monetary and capital requirement policy

are completely orthogonal, no co-ordination is necessary. In that world monetary policy would

only focus on price stability, while capital requirement policy would only address financial stability.

However, if one instrument affects the transmission of the other, then this will need to be taken into

account by the corresponding policy committee to avoid under or overshooting of the target, which

can have socially undesirable consequences. Whether co-ordination is desirable or not therefore

depends on whether these instruments reinforce the effects of each other. Economic theory suggests

that these two instruments should affect the transmission of each other, but the direction of the

effect is unclear. The theory has explored the extent to which these two instruments affect the

transmission of each other through three different channels: thebank capital channel, therisk-taking

channel and theterm-structure channel of monetary policy.

Thebank capital channel of monetary policy predicts that monetary policy and changes in capital

requirements reinforce the effects of each other. Van den Heuvel (2002) shows that an unexpected

monetary policy contraction can lead to smaller capital buffer, as a result of realised interest rate

risk. This happens because of the maturity mismatch on banksbalance sheets between assets (long

duration) and liabilities (short duration), so that an increase in the interest rate causes profits and

hence capital to decline. This means that a coincident rise in capital requirements will have a larger

impact on the loan supply, as it is likely to be more binding.

Therisk-taking channel of monetary policy suggests instead that the sign of the interaction may

be asymmetric, depending on the sign of monetary policy. In an environment where banks target

a fixed nominal return, a monetary policy expansion and the associated reduction in interest rates

may lead to a search for yield and a rise in bank leverage (Borio and Zhu (2008), Adrian and

Shin (2011)). Empirical evidence from Spain (Jimenez et al. (2014b)) and Bolivia (Ioannidou et

al. (2014)) points out that a lower overnight rate induces lowly capitalized banks to take on more

history with nonperforming loans and a higher subsequent probability of default. This may further

lead banks to reduce capital buffers. Given that banks with tight capital buffers are more likely to

cut back risk-weighted assets, a change in capital requirements will have a greater impact on loan

supply in this situation. On the other hand, during periods of monetary policy tightening, it is not

clear how capital buffers would respond. In that situation a rise in capital requirement may be less

binding on the actual capital ratio and therefore have a smaller impact on the loan supply. In other

words, it is plausible that the sign of the interaction between these two instruments depends on the

sign of the monetary policy action.

Finally, Thakor (1996) argues that the sign of the interaction between these two instruments will

depend on the reaction of the term structure of interest rates. If, following a monetary expansion,

long rates fall by more (less) than short rates, implying a decrease (increase) in the interest rate

term premium, long–term government securities will become less (more) profitable, compared to

lending. Since in the presence of risk–based capital requirements government securities have a zero–

risk weight, the incentive to shift to lending (bonds) increases. In that case, a coincident decline

in capital requirements will lead to a smaller (greater) impact on the loan supply. Whether or not

monetary policy reinforces or counteracts changes in capital requirements therefore depends on the

yield curve reaction.

Despite this rich body of economic theory, empirical work that attempts to test these different

transmission mechanisms is still scarce. Aiyar, Calomiris and Wieladek (2014c) are one of the first

studies to undertake this task with UK bank-level balance sheet data. Across a large variety of

many different specifications, they do not find any statistical evidence that these two tools reinforce

each other. In this paper, we repeat this exercise, but with two important differences. We have

more granular data and a more exogenous measure of UK monetary policy. Specifically, we use the

(2004) series of exogenous monetary policy shocks for the UK. From an econometric modelling

perspective, we assume that monetary policy affects asset growth of the borrowing firms through

exactly the same channels as changes in capital requirements. That is we again assume that firms

will be less affected by monetary policy changes as the bank-firm relationship becomes longer over

time.

The results from this specification are shown in Table 11. Column (1) shows that once monetary

policy is included, a 100 basis points rise in monetary policy leads to an asset growth contraction

of about 4.9%, slightly smaller than the 6.9% contraction following a 100 basis points rise in the

capital requirement ratio. Column (2) adds the interactions between the monetary policy and

capital requirement terms. Neither ∆KRj,t×M P shockt nor ∆KRj,t×M P shockt×1/(1 +Li,j,t)

have a significant effect on the growth rate of assets. This suggests that, at first sight, there is no

interaction as in Aiyar, Calomiris and Wieladek (2014c) and contrary to the bank capital channel

in Van den Heuvel (2002). Column (3) introduces a triple (and quadruple) interaction term of

capital requirements and monetary policy shocks with annual changes in the term premium (and

1/(1 +Li,j,t)) to examine to which extent the term premium channel (Thakor (1996)) operates.

All the interaction terms between the monetary policy shock and capital requirements changes

are not significant, suggesting that the term structure does not matter in this case. Column (4)

allows the interactions to vary with the sign of the monetary policy surprise, by interacting the

corresponding coefficients with a dummy variable (T IGHTt) that takes the value of one during a

monetary policy tightening and zero otherwise. First of all, notice that the monetary policy shock

has an independent and significant negative impact on the growth rate of assets only for a monetary

policy tightening (-12.8%) and not for a loosening. Further, all the interaction terms (triple or

quadruple) between capital requirements and the monetary policy shock are now significant. In

requirements in the case of a monetary policy expansion (+0.0364-0.157=-12%), so that the two

policies reinforce each other. During a monetary policy contraction, on the other hand, the sign of the

monetary policy capital requirement interaction switches (+0.0364-0.157-0.077+0.348=+15%), so

that the two policies attenuate each other if used simultaneously. Overall, these results are consistent

with the risk-taking channel of monetary policy, that suggests that the two policies reinforce each

other only in the case of a monetary policy expansion.

3.6 Credit Substitution: Multiple Relationship and Other