Bank lending mechanism of monetary policy transmission: The role of Bank Capital, Bank Competition, and financial development

Abstract

Many studies have attempted to untangle the function of financial institutions in the transmission mechanism of monetary policy, as they have found several critical components in this process. Among well-established channels, the bank lending mechanism of monetary policy pass-through has been a recurring theme in contemporary monetary policy research in this respect. To what extent does the bank loan supply depend on monetary policy? And does this relationship vary with bank capital, competition, and financial development? These questions have been addressed in prior studies; however, there are several significant gaps that need further investigation. Specifically, research on the ineffectiveness of monetary policy pass-through for well-capitalized banks is conducted; however, the dependence of lending response to both monetary regimes on various levels of bank capital remains scarce. In addition, the distributional impact of monetary policy on bank loan supply conditioned by bank competition and financial development has been explored in limited research; however, the case of Vietnam with a multiple-tool regime is rather ignored. To examine the role played by bank capital, bank competition, and financial development in the effectiveness of monetary policy in response to aforementioned voids, from the perspective of the bank lending mechanism, an unbalanced disaggregate data for a relatively comprehensive sample of 30 commercial banks in Vietnam over the period of 2007–2020 is employed along with two-step system generalized method of moments and marginal effect analysis. To facilitate the understanding of research findings, a normalized application for bank-specific characteristics is adopted. Furthermore, the nested step-wise approach and alternative proxies for variables of interest (i.e., bank competition, financial development, and monetary policy) are employed to make results more robust. xi After confirming the presence of BLM in the case of Vietnamese commercial banks, the findings also reveal that (i) The potency of monetary policy transmission via the bank lending mechanism depends on different levels of bank capital and each regime of monetary policy. For more details, in a period of contractionary monetary policy, the influence of monetary policy on bank loan supply is inconclusive for banks with capital levels close to the mean value of normalized capital. In contrast, the ineffectiveness of monetary policy is evident for banks with high capital. For banks with low levels of capital, their loan supply is more responsive to tightening monetary policy. In a period of monetary expansions, better-capitalized banks can benefit more because they can raise more lending proportionally than those with lower levels of capital; (ii) Banks with a high degree of competitiveness may be better at mitigating the effects of monetary policy shocks. This might be explained by the fact that a bank with stronger market power will have a greater capacity to hedge against a monetary shock due to relatively easy access to funding sources and favourable conditions in the financial markets; (iii) As financial markets continuously proceed, commercial banks become less responsive to monetary policy shocks, meaning that monetary policy implementation is ineffective in the context of financial market expansion. This is possible because Vietnamese commercial banks may be exposed to a variety of financial instruments and funding sources as a result of financial growth, which may shield them from the unfavourable consequences for loanable bank funds and, hence, bank loan supply induced by monetary policy tightening shocks.