International Spillovers and Local Credit Cycles

This paper studies the transmission of the Global Financial Cycle (GFC) to domestic credit market conditions in a large emerging market, Turkey, over 2003–13. We use administrative data covering the universe of corporate credit transactions matched to bank balance sheets to document four facts: (1) an easing in global financial conditions leads to lower borrowing costs and an increase in local lending; (2) domestic banks more exposed to international capital markets transmit the GFC locally; (3) the fall in local currency borrowing costs is larger than foreign currency borrowing costs due to the comovement of the uncovered interest rate parity (UIP) premium with the GFC over time; (4) data on posted collateral for new loan issuances show that collateral constraints do not relax during the boom phase of the GFC.

Banks and Negative Interest Rates

In this article, we review the nascent literature on the transmission of negative policy rates. We discuss the theory of how the transmission depends on bank balance sheets, and how this changes once policy rates become negative. We review the growing evidence that negative policy rates are special because the pass-through to banks’ retail deposit rates is hindered by a zero lower bound. We summarize existing research on the impact of negative rates on banks’ lending and securities portfolios as well as their consequences for the real economy. Finally, we discuss the role of different initial conditions when the policy rate becomes negative, and potential interactions between negative policy rates and other unconventional monetary policies. Expected final online publication date for the Annual Review of Financial Economics, Volume 13 is November 2021. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

The Pandemic's Impact on Credit Risk: Averted or Delayed?

The COVID-19 recession resulted in historic unemployment and a significant shock to much of the service sector. Despite these macroeconomic challenges, banks' risk-based capital buffers remain high and the number of bank failures remains low. Government relief programs, including the Coronavirus Aid, Relief, and Economic Security (CARES) Act, both directly and indirectly helped stabilize bank balance sheets during the crisis.

Monetary Policy Spillovers Under Covid-19: Evidence from U.S. Foreign Bank Subsidiaries

This paper uses Call Report data to examine the impact of home country monetary policy on foreign bank subsidiary lending in the United States during the COVID-19 pandemic. Examining a large sample of foreign bank subsidiaries and domestic U.S. banks, we find that foreign bank lending growth was positively associated with both lower home country policy rates and negative home country rates. Our point estimates indicate that a one standard deviation decrease in home country policy rates was associated with a 3.5 percentage point increase in lending growth while negative home country policy rates added an additional 3.0 percentage points on average. Disparities in sensitivity to home country rates also exist by bank size, as large banks exhibited more responsiveness to home country policy rate levels, but were less responsive to negative policy rates. Easier home country policy rates are also found to impact negatively in growth in capital ratios and bank income, in keeping with expanded foreign subsidiary activity. However, income responses to negative home country rates are mixed, in a manner suggestive of sophisticated adjustment of global bank balance sheets to changes in relative home and host country monetary policy stances. Overall, our findings confirm that the bank lending channel for global monetary policy spillovers was active during the pandemic crisis.

Stay Competitive in the Digital Age

The latest advancement in financial technology has posed unprecedented challenges for incumbent banks. This paper analyzes the implications of these challenges on bank competitveness, and explores the factors that could support digital advancement in banks. The analysis shows that the traditionally leading role of banks in advancing financial technology has diminished in recent years, and suggests that onoing efforts to catch up to the digital frontier could lead to a more concentrated banking industry, as smaller and less tech-savvy banks struggle to survive. Cross-country evidence has suggested that banks in high-income economies appear to have been the digital leaders, likely benefiting from a sound digital infrastructure, a strong legal and business environment, and healthy competition. Nonetheless, some digital leaders may fall behind in the coming years in adopting newer technologies due to entrenched consumer behavior favoring older technologies, less active fintech and bigtech companies, and weak bank balance sheets.

Bank Balance Sheets and External Shocks in Asia

In emerging Asia, banks constitute the dominant source of financing consumption and investment, and bank balance sheets comprise large gross FX assets and liabilities. This paper extends the DSGE model of Gertler and Karadi (2011) to incorporate these key features and estimates a panel vector autoregression on ten Asian economies to understand the role of the banking sector in transmitting spillovers from the global financial cycle to small open economies. It also evaluates the effectiveness of foreign exchange intervention (FXI) and other macroeconomic policies in responding to external financing shocks. External financial shocks affect net external liabilities of banks and the exchange rate, leading to changes in credit supply by banks and investment. For example, a capital outflow shock leads to a deprecation that reduces the net worth and intermediation capacity of banks exposed to foreign currency liabilities. In such cases, the exchange rate acts as shock amplifier and sterilized FXI, often deployed by Asian economies, can help cushion the economy. By contrast, with real shocks, the exchange rate serves as a shock absorber, and any FXI that weakens that function can be costly. We also explore the effectiveness of the monetary policy interest rate, macroprudential policies (MPMs) and capital flow management measures (CFMs).

International Monetary Frameworks

In this chapter we turn to representing flows of funds in alternative international monetary frameworks, and what global liquidity these different frameworks provide. We first recall some arguments in favour of and against fixed exchange rate systems. We then introduce two international monetary arrangements of the past which imply fixed exchange rates, namely the gold standard and the Bretton Woods system, and recall why both eventually failed. We then turn to three international monetary frameworks in the context of the current paper standard, i.e. fixed exchange rate systems, flexible exchange rate systems, and the European monetary union. We explain the role of an international lender of last resort and related solutions, and how these allow for more leeway in running fixed exchange rate systems. We also show how banks and central bank balance sheets are affected by international flows of funds and the balance of payments. Finally, we briefly review recent developments of foreign currency reserves, being the key central bank balance sheet position in this context.

Conventional Monetary Policy

This chapter introduces conventional monetary policy, i.e. monetary policy during periods of economic and financial stability and when short-term interest rates are not constrained by the zero lower bound. We introduce the concept of an operational target of monetary policy and explain why central banks normally give this role to the short-term interbank rate. We briefly touch macroeconomics by outlining how central banks should set interest rates across time to achieve their ultimate target, e.g. price stability, and we acknowledge the complications in doing so. We then zoom further into monetary policy operations and central bank balance sheets by developing the concepts of autonomous factor, monetary policy instruments, and liquidity-absorbing and liquidity providing balance sheet items. Subsequently we explain how these quantities relate to short-term interest rates, and how the central bank can rely on this relation to steer its operational target, and thereby the starting point of monetary policy transmission. Finally, we explain the importance of the collateral framework and related risk control measures (e.g. haircuts) for the liquidity of banks and for the conduct of central bank credit operations.