Lending Channel of Monetary Policy: Does Market Power Matter? Evidence from South Asia
- AIOR Admin
- Aug 14
- 2 min read
Antonette Fernando
Central Bank of Sri Lanka
This paper examines the impact of market power in the banking industry on the monetary policy transmission mechanism in emerging South Asian economies. The analysis focuses on the effect of market power on the bank lending channel, which stresses the impact of monetary policy on the supply of bank loans. Undoubtedly, banks play a vital role in the lending channel of monetary transmission. In a monetary policy contraction, banks may curtail the supply of loans if they are not able to restore their lost loanable funds. Such a reduction in loan supply increases the cost of credit for loan-dependent economic agents unless these borrowers resort to obtaining capital from alternative sources. However, this depends on the degree of capital market development in the country or the accessibility of foreign direct investments. In their absence, a monetary contraction decreases the employment and output levels of the economy. Since the global financial crisis in 2008, researchers have shown interest in re-examining how monetary policy transmission can be made more effective through the generation of new bank credits. The empirical analysis uses a unique bank-level annual panel dataset for 125 commercial banks in Bangladesh, India, Nepal, Pakistan, and Sri Lanka over the period 2015–2022. Using several structural measures of market power in the banking industry, the results provide evidence that a higher concentration in the banking industry tends to weaken monetary policy transmission through the bank lending channel. These findings are robust to a broad range of sensitivity checks, including alternative measures of monetary policy and different specifications. The analysis is extended to examine the way in which bank-specific characteristics alter the relationship between bank concentration and the strength of the lending channel. The results suggest that the weakening effect is more substantial for small, less-liquid, poorly-capitalised and less-profitable banks. These results are consistent with the existing literature showing that financially constrained banks are less insulated from monetary contractions, as they do not have easy access to alternative sources of funds.
Comments