Empirical banking ENSAE/PSE M2. Section 5: Banks and the transmission of monetary policy
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1 Empirical banking ENSAE/PSE M2 Section 5: Banks and the transmission of monetary policy Jean-Stéphane Mésonnier Banque de France Disclaimer: Opinions expressed are the author s own and do not necessarily reflect the views of the Banque de France
2 «Long and variables lags» Source: ECB JS MESONNIER - Empirical Banking - Spring term
3 Overview 1. The bank lending channel in normal times 2. The risk-taking channel of monetary policy 3. Lender of last ressort operations and zombie-lending 4. The bank lending channel in crisis times: the Eurosystem s LTROs JS MESONNIER - Empirical Banking - Spring term
4 References Kashyap, Anil K. and Jeremy C. Stein. What Do A Million Observations On Banks Say About The Transmission Of Monetary Policy?, AER, 2000, 90(3,Jun), Jimenez, Gabriel, Ongena, Steven, Peydro, Jose-Luis and Saurina, Jesus, (2012), Credit Supply and Monetary Policy: Identifying the Bank Balance-Sheet Channel with Loan Applications, AER, 102, issue 5, p Jiménez, Gabriel, Ongena, Steven, Peydro, Jose-Luis and Saurina, Jesús, (2014), Hazardous Times for Monetary Policy: What Do Twenty Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk Taking?, Econometrica, 82, issue 2, p Itamar Drechsler, Thomas Drechsel, David Marques-Ibanez and Philipp Schnabl (2014), Who Borrows From the Lender of Last Resort? Journal of Finance, forthcoming Andrade, P., Cahn, C., Fraisse, H. and J.-S. Mésonnier (2015), Can the Provision of Long-term Liquidity Help to Avoid a Credit Crunch? Evidence from The Eurosystem s LTROs, Banque de France Working Paper JS MESONNIER - Empirical Banking - Spring term
5 The bank lending channel of monetary policy Modern MP s stance defined by current and future expected levels of policy rates. Key channels of transmission: Interest rate (+ expectations) channel: term structure of yield curve + pass-through to bank loan rates (old «money view») => real LT rates => investment Asset and collateral prices: FX rate and CIRP, Tobin s Q, financial accelerator (Bernanke and Gertler, 1989, 1995) and the broad credit channel Bank lending channel (Bernanke and Blinder, 1998, 1992)(old «credit view) => credit supply Old (textbook) deposit-reserve multiplier mechanism vs more recent emphasis on financial frictions / issuance of uninsured deposits when policy rate hike JS MESONNIER - Empirical Banking - Spring term
6 Kashyap and Stein, 2000: What do a million observations on banks say Earlier work on credit channel: macro VARs (Ramey, 92, Bernanke and Blinder, 1992) or macro regressions using reconstructed growth rates for bank size buckets (Kashyap and Stein, 1995) or analysis of changes in finance mix (Kashyap, Stein, Wilcox, 1993): Demand vs supply pb + possible compositional shift in demand Objective of KS: identifying the bank lending channel by exploiting response heterogeneity in a large cross section of banks Motivation: M&M does not hold in the short run: issuance of uninsured deposits (or CDs) costlier (less feasible) than issuance of insured deposits When MP tightens, smaller, less liquid, less capitalized banks face more difficulties in substituting for vanishing demand deposits Hence relatively higher loan rates and/or decreasing loan supply JS MESONNIER - Empirical Banking - Spring term
7 KS 2000: Main hypotheses For constrained banks (small Balance sheet strength B): d²l/dbdm <0 Two readings: constraints (dl/db) tighter when MP is itself tight (M high) Reaction stronger (dl/dm) when constraints bind more (B smaller) Focus on small banks (hyp: effect stronger): d(d²l/dbdm)/dsize > 0 Empirical couterpart: triple interaction = MP * BS strength * Size BS strength : capital/assets or liquid assets/assets Focus on subsamples of small vs large banks JS MESONNIER - Empirical Banking - Spring term
8 KS 2000: Data Income statements and balance sheets for all banks reporting to the Fed (Call reports) Quarterly, Some 1 million bank-quarter observations Challenges Methodological breaks in BS items definition => reconstructing meaningful time series Individual bank level information (baseline). Robsutness using BHC level info. JS MESONNIER - Empirical Banking - Spring term
9 KS 2000: Bank balance sheets by size buckets JS MESONNIER - Empirical Banking - Spring term
10 KS 2000: Measures of Monetary Policy JS MESONNIER - Empirical Banking - Spring term
11 KS 2000: Methodology Two-step approach (variant of [2] includes GDP growth and lags): JS MESONNIER - Empirical Banking - Spring term
12 KS 2000: Methodology (2) One-step approach: Lit regressed on Bit-1, DMt, and Bit-1* DMt + controls Pros & cons of one-step vs two-steps approches? JS MESONNIER - Empirical Banking - Spring term
13 KS 2000: Results of 2-step estimation JS MESONNIER - Empirical Banking - Spring term
14 KS 2000: Results of one-step estimation JS MESONNIER - Empirical Banking - Spring term
15 JOPS 2011: Credit supply and monetary policy: identifying the credit channel with loan applications Macro and bank-level regressions cannot adress correctly two identification challenges of the BLC of MP Loan supply vs demand MP rate may be determined by business cycle conditions (Taylor rule) Objective: identify the bank lending channel using loan applications data for Spain Witin-firm-month: applications to different banks (firm-month FE) Within-loan: applications to different banks (firm-loan FE) Euro area MP quite exogenous for Spain before the crisis JS MESONNIER - Empirical Banking - Spring term
16 JOPS 2012: Data Spanish credit register: all C&I loans > 6,000 EUR + loan applications : > 350 banks and > 130,000 firms present each quarter Banks receive automatically information about current borrowers (total debt + defaults) Banks can request information about loan applicants => signals loan applications by new borrowers (no ever-greening) Matched with BdE supervisory information on banks balance sheet (monthly) + Spanish Mercantile Register: yearly firms balance sheets. Specifications with firm info: 816,000 observations. Specifications with FE: about 2,335,000 observations. JS MESONNIER - Empirical Banking - Spring term
17 JOPS 2012: Variable definition and data summary JS MESONNIER - Empirical Banking - Spring term
18 JOPS 2012: Econometric model JS MESONNIER - Empirical Banking - Spring term
19 JS MESONNIER - Empirical Banking - Spring term
20 JS MESONNIER - Empirical Banking - Spring term
21 JOPS 2012: Can excluded borrowers fund elsewhere? JS MESONNIER - Empirical Banking - Spring term
22 JS MESONNIER - Empirical Banking - Spring term
23 JS MESONNIER - Empirical Banking - Spring term
24 JOPS 2014: Hazardous times for MP Do low MP rates spur risk-taking by banks, thus sowing the seeds of financial crises? «Fed was too low for too long in » (John Taylor) Possible mechanisms: low policy rates may: Reduce threats of deposit withdrawals Improve banks financial health, reducing incentives to monitoring Incentivize «search-for-yield» behavior JOPS use again Spanish Credit Register data to analyze intensive and extensive margins of loan supply and riskiness of accepted borrowers when MP is loose Similar data as JOPS 2012, JS MESONNIER - Empirical Banking - Spring term
25 JOPS 2014: Identification strategy Three components to identify the effect of loose MP on banks risk taking Interact MP rate (ECB repo) and bank capital ratio Control for bank and firm heterogeneity: time*bank and firm*bank FE When possible: control for non random bank-firm matching with bank-firm FE Use short term and long term rates to better qualify the MP stance Bottom line: weak banks lend relatively more (number and size of loans) to risky borrowers when short-term rate is low No significant effect of low LT rate JS MESONNIER - Empirical Banking - Spring term
26 JOPS 2014: Summary stats JS MESONNIER - Empirical Banking - Spring term
27 JOPS 2014: Model specifications (intensive margin) JS MESONNIER - Empirical Banking - Spring term
28 JOPS 2014: Results, intensive margin (1) JS MESONNIER - Empirical Banking - Spring term
29 JOPS 2014: Results, intensive margin (2) JS MESONNIER - Empirical Banking - Spring term
30 JOPS 2014: Results, extensive margin of ended credit relationships (1) JS MESONNIER - Empirical Banking - Spring term
31 JOPS 2014: Results, extensive margin of new credit relationships (1) JS MESONNIER - Empirical Banking - Spring term
32 JOPS 2014: Results, extensive margin of new credit relationships (2) JS MESONNIER - Empirical Banking - Spring term
33 JS MESONNIER - Empirical Banking - Spring term
34 DDMS 2014: LLOR operations and bank risk taking Can unlimited provision of central bank liquidity in a crisis (LLOR operations) increase bank risk taking? Unintended consequence of LLOR, which may exacerbate financial instability? DDMS: exploit detailed ECB collateral data + bank level data during the euro area crisis (post-lehman up to the Greek crisis mid-2010). They find: Weaker banks borrowed more from the ECB and pledged riskier collateral with the ECB They also invested more this cheap money in distressed sovereign bonds, notably domestic ones Risky collateral shifted from sound to weak banks JS MESONNIER - Empirical Banking - Spring term
35 DDMS 2014: ECB liquidity injections after Lehman October 2008: fixed rate full allotment procedure = excess liquidity DFR becomes effective policy rate: EONIA drops at DFR, but banks borrow at the (higher) repo rate : 6- and 12-month LTROs, some extension of eligible collateral + ECB starts to offer haircut subsidies to some assets with widening haircuts in the private repo market (e.g. Portuguese bonds) Ex.: haircut on 5y Portuguese sovereign: ECB = 4%, market = 10% DDMS: looks like LLOR under the Bagehot principles Lend freely at penalty rate against (ex ante) sound collateral JS MESONNIER - Empirical Banking - Spring term
36 DDMS 2014: Data Exhaustive dataset of collateral pools by pledged European banks with the Eurosystem (ECB), weekly frequency Consolidated information from reports for all individual banks Individual securities in collateral pool pledged, by ISIN Bank balance sheet info from Bankscope ECB ratings database (mostly from Moody s) => measure of banks soundness in 2007 (ex ante) EBA stress tests: data on bank groups sovereign debt holdings CDS and equity prices for listed banks JS MESONNIER - Empirical Banking - Spring term
37 JS MESONNIER - Empirical Banking - Spring term
38 DDMS 2014: main regressions JS MESONNIER - Empirical Banking - Spring term
39 DDMS 2014; preliminary evidence of collateral arbitrage against the LLOR JS MESONNIER - Empirical Banking - Spring term
40 DDMS 2014: weak vs well capitalized banks JS MESONNIER - Empirical Banking - Spring term
41 JS MESONNIER - Empirical Banking - Spring term
42 JS MESONNIER - Empirical Banking - Spring term
43 JS MESONNIER - Empirical Banking - Spring term
44 DDMS 2014: results: bank rating and ECB borrowing JS MESONNIER - Empirical Banking - Spring term
45 DDMS 2014: Distressed sovereigns: held and pledged by weak banks JS MESONNIER - Empirical Banking - Spring term
46 Robustness: only mildly confounding country-specific trends JS MESONNIER - Empirical Banking - Spring term
47 Note: coefficient should be zero according to classic LLOR if no panic in these countries JS MESONNIER - Empirical Banking - Spring term
48 DDMS 2014: the political economy of LLOR borrowing JS MESONNIER - Empirical Banking - Spring term
49 DDMS 2014: Evidence of financial repression? JS MESONNIER - Empirical Banking - Spring term
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