Jenee Stephens, Dave Seerattan, DeLisle Worrell Caribbean Center for Money and Finance 41 st Annual Monetary Studies Conference November 10 13, 2009

Transcription

1 Jenee Stephens, ave Seerattan, esle Worrell Carbbean Center for Money and nance 41 st Annual Monetary Studes Conference November 10 13,

2 OUTINE! Introducton! Revew of lterature! The Model! Prelmnary Analyss The Jamacan Experence: Impulse Response of endng and epost Rates! Concludng observatons! rectons for future research! Questons and comments 2

3 Introducton! The effectveness of monetary polcy n Carbbean economes s predcated on the responses of commercal banks to monetary polcy ntatves.! In most countres the banks are the domnant source of credt and repostory of fnancal labltes, and therefore the only channel by whch monetary polcy nfluences aggregate expendture. (The exceptons are Jamaca and Trndad and Tobago, where collectve nvestment vehcles have grown to rval banks n sze, but even n these two countres monetary polcy s amed prncpally at affectng bank behavour.)

4 Introducton! Ths paper explores the ratonale for expectng a proft maxmzng bank to adjust depost and loan rates n response to central bank ntatves.! The focus s on the nterest responses that the bank would be expected to make n response to monetary ntatves, based on proft maxmzng behavour.

5 What motvates monetary polcy? INKS IN THE MONETARY TRANSMISSION MECHANISM *Assumptons!All excess lqudty s absorbed!banks wll not borrow abroad!banks expect changes to persst!there s evdence of nterest elastcty of loans and deposts!evdence of nterest elastcty of expendture 5

6 What motvates monetary polcy? Consderatons affectng banks reacton! Is the central bank rate lkely to persst or be reversed?! How should they adjust ther depost and loan rates, f at all, n order to become more proftable? Are there sgnfcant nterest elastctes of loans and deposts? Would t be proftable to wden/narrow the spread? Whch rate to adjust frst?! What wll other banks do?! What wll non bank compettors do?! Wll there be any captal nflow or outflow? 6

7 What s the role of lqudty?! Optmal level of lqudty s a necessary condton for the functonng of the transmsson mechansm! A flood of excess lqudty weakens the lnk between changes n the central bank s monetary polcy and the ntended changes n the commercal rates. 7

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9 terature Revew The relatonshp between nterest rates and lqudty! Conventonally negatve relatonshp between nterest rates and lqudty! Relatonshp s a sde effect of olgopolstc bankng sectors. Adjustments to the loan rates (and spreads) due to lqudty cost mposed by the central bank at the dscount wndow. {Baglon (2000)}! A central bank that s preoccuped wth stemmng excess lqudty may opt to ncrease ts dscount rate to dssuade borrowng at the dscount wndow. If banks compensate themselves by rasng loan rates, the relatonshp between lqudty and spreads s weakened. 9

10 terature Revew The relatonshp between nterest rates and lqudty cont d! Weakenng effect of nvoluntary excess lqudty on monetary transmsson mechansm n Sub Saharan Afrca esp. Ngera and Uganda where commercal banks rates are unresponsve to central bank nfluence when they hold nvoluntary excess reserves {Saxeguard (2006)}! Amdst olgopolstc loan markets n some C bean terrtores, monetary polcy s neffectve when excess unremunerated reserves become substtutes for loans at a hgh lendng rate. qudty shocks from the central banks wll only affect the loan rate (and spreads) f the exstng loan rate s very hgh. {Khemraj (2008)} 10

11 terature Revew A Closer ook at the Bankng Channel! Bankng channel defned as the factors allowng central banks nterest rate polces to mpact the supply of loans {Brooks (2007)}! In Turkey, the effect of monetary polcy may stream through the bankng channel gven bankng sector s lqudty poston provded that " banks cannot wholly sheld themselves from a declne n lqud funds by outsourcng fnancng wthout ncurrng sgnfcant costs, and " There s a sgnfcant pool of borrowers that are unable to nsulate ther expendture from the reducton n bank credt {Brooks (2007)} 11

12 terature Revew A Closer ook at the Bankng Channel cont d! Elastcty of loan supply to monetary polcy s subject to bank characterstcs. " Smaller banks suffer dsproportonately due to dffculty n rasng funds " More lqud banks are able to tap nto assets and reduce lendng by smaller proportons " More leveraged banks respond more! In Brazl bankng channel performs lmted role n monetary transmsson as follows " The change n bankng spreads nflates the ntertemporal effect of monetary polcy on lqudty absorpton " Ths s offset by the short run expansonary effect of exchange rate apprecaton (consstent wth tghtenng polcy)on bank credt {Catao et al (2008)} 12

13 terature Revew A Closer ook at the Bankng Channel cont d! In Colomba there s a long run relatonshp between polcy and bank nterest rates. However there s a low elastcty of lendng and depost rates to changes n polcy rate due to fnancal structure and mperfect nformaton. {Betancourt et al (2008)}! Inflexblty of nterest rates n the short run due to degree of competton n the bankng sector, the sze of the banks and loan rsk level.{bernsten and uentes (2003)}! Inelastcty also explaned by the ncreased holdngs of government paper as a substtute for loans and decreased leverage fnancng. {Huertas et al (2005)} 13

14 terature Revew! In Jamaca, the total loans most responsve to the reverse repo rate. Response s lagged.! The mpulse response functon show the value of loans decreasng after two perods.! Varance decomposton show shocks to the 30 day reverse repo rate begns to contrbute sgnfcantly to changes n credt demand and supply after four months.! More domestcally lqud banks wll be mpacted less by monetary tghtenng amed domestc currency prces stablty snce they are better able to nsulate ther loan poston whle foregn lqud banks may fnd dffcult to access foregn funds at the nstance of the shock and hence may respond more. {Urquhart (2008)} 14

15 Thngs to Note! Banks hold excess unremunerated reserves thus central bank ntatves enacted at the dscount wndow are neffectve. Banks do not borrow from the dscount wndow.! Commercal banks are the prmary source of retal credt, partcularly on the small and medum scale.

16 THE MOE B d B r d B B B B B B q = + = + + = = + + = + + = / } { / } { The bank s maxmzaton problem s:

17 THE MOE cont d! The framework defnes the commercal banks response to open market operatons, whch alter the nterest rate on treasury bonds (and n the case of Jamaca, Bank of Jamaca certfcates of depost) held by the banks.! In adjustng loan and depost rates to maxmze profts, banks wll take account of the elastcty of ther own holdngs of foregn assets to changes n loan and depost rates, and the nterest elastcty of loans (δ/δr l )and deposts (δ/δr d ).

18 Prelmnary Analyss! ata! The Sample Perod: 1998/2 to 2008/12! Sources: Internatonal nancal Statstcs Bank of Jamaca! Methodology! Multvarate VAR nclusve of the lendng and depost rates, nflaton, the central bank s certfcate of depost rate, total loans, total deposts and excess lqudty (excess reserves).

19 Response to Cholesky One S.. Innovatons ± 2 S.E

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21 What next?! Extend the methodology to other Carbbean countres.! Examne the elastcty of banks holdngs of foregn to changes n the lendng and depost rates, whch also factors nto determnng the proft maxmzng nterest rate.! Polcy recommendatons specfcally amed at mprovng the effectveness of the monetary polcy nstruments va the bankng channel.