The Lending Channel in Emerging Economies: A Look at the International Evidence

Abstract

This thesis studies the role of banks in the transmission of nominal shocks into credit markets in emerging countries. It builds on the lending channel hypothesis, which states that, due to imperfections in capital markets, banks may not be able to completely offset a negative shock to deposits with other sources of finance. As a result, they may choose to cut credit, affecting the financing possibilities of bank-dependent firms and amplifying the effects of monetary shocks on economic activity.

Empirical work on the lending channel in emerging countries is scarce. This thesis argues that, since the mechanism relies on the presence of imperfections in capital markets, it should be expected to be stronger in emerging countries. Therefore, looking at the cross-country evidence provides a source of variation that has not been previously exploited in the literature.

The thesis is divided in three chapters. The first develops a model of the lending channel in a small open economy to study how differences in the severity capital market imperfections affect the power of the mechanism. The second takes of the model to the data, using a bank-level panel dataset of 832 banks in 27 countries during 1986-1998. The chapter tests for systematic cross-sectional differences in the response of loan growth to monetary conditions across banks of various characteristics and across developed and emerging countries. The third chapter further looks at the evidence from emerging markets, using differences in bank ownership to proxy for unobserved financial constraints facing banks. In particular, it builds on the presumption that foreign banks operating in emerging markets are less financially constrained than domestic. The test exploits a novel bank-level dataset comprising 1565 banks in 20 emerging countries during 1989-2001, to look for systematic differences across domestic and foreign banks.

The results are supportive of the existence of a lending channel mechanism that is stronger in emerging countries. On the other hand, the behavior of domestic and foreign banks is not found to be markedly different, which may imply that foreign banks in emerging countries are prevented from freely resorting to upstream financing from their mother institutions.