The Bank Lending Channel: a FAVAR Analysis

Journal of money credit and banking (Impact Factor: 1.09). 01/2009; 45(4). DOI: 10.1111/jmcb.12067
Source: RePEc


We examine the role of commercial banks in monetary transmission in a factor-augmented vector autoregression (FAVAR). A FAVAR exploits a large number of macroeconomic indicators to identify monetary policy shocks, and we add commonly used lending aggregates and lending data at the bank level. While our results suggest that the bank lending channel (BLC) is stronger than previously thought, this feature is not robust. In addition, our results indicate a diffuse response to monetary innovations when individual banks are grouped according to asset sizes and loan components. This suggests that other bank characteristics could improve the identification of the BLC.

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Available from: Chetan Dave, Oct 10, 2014
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    • "7 Bernanke et al. (2005) propose a factor-augmented vector autoregressive model (FAVAR) based on the development of principal components analysis outlined by Stock and Watson (2002). A factor-augmented approach has been used by Dave et al. (2013) to isolate the bank lending channel in monetary transmission of US monetary policy and by Gilchrist et al. (2009) to assess the impact of credit market shocks on the US activity. One of the main advantages of this methodology is that a single individual variable or factor can capture the dynamic of a large amount of information contained in many variables. "
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    • "While close in spirit to ours, these studies do however not deal directly with monetary policy transmission and do not consider disaggregated bank data. By contrast, Dave et al. (2009) investigate the dynamic response of both credit aggregates and bank level loan growth measures to a monetary policy shock using disaggregated US bank data. However, they mainly focus on the differentiated responses of different types of loans, in the spirit of Den Haan et al. (2007), and do not use their FAVAR model to assess as we do whether fluctuations in banks' financial conditions (and their dispersion) significantly alter the transmission of monetary shocks to the broader macroeconomy. "
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    ABSTRACT: We propose a novel approach to assess whether banks’ financial conditions, as reflected by bank-level information, matter for the transmission of monetary policy, while reconciling the micro and macro levels of analysis. We include factors summarizing large sets of individual bank balance sheet ratios in a standard factor-augmented vector autoregression model (FAVAR) of the French economy. We first find that factors extracted from banks’ liquidity and leverage ratios predict macroeconomic fluctuations. This suggests a potential scope for macroprudential policies aimed at dampening the procyclical effects of adjustments in banks’ balance sheet structures. However, we also find that fluctuations in bank ratio factors are largely irrelevant for the transmission of monetary shocks. Thus, there is little point in monitoring the information contained in bank balance sheets, above the information already contained in credit aggregates, as far as monetary policy transmission is concerned.
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    ABSTRACT: We analyze the link between banks and the macroeconomy using a model that extends a macroeconomic VAR for the U.S. with a set of factors summarizing conditions in about 1,500 commercial banks. We investigate how macroeconomic shocks are transmitted to individual banks and obtain the following main findings. Backward-looking risk of a representative bank declines, and bank lending increases following expansionary shocks. Forward-looking risk increases following an expansionary monetary policy shock. There is, however, substantial heterogeneity in the transmission of macroeconomic shocks, which is due to bank size, capitalization, liquidity, risk, and the exposure to real estate and consumer loans.
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