Monetary Policy and Credit Supply

In the last post I discussed the ‘new empirical banking literature’. I explained that the main advance of this literature is to control for any firm heterogeneity, which determines most of the credit demand. They can do that because they have access to credit registers, which have loan-level data. In this post I will discuss Jiménez et al. (2012), which use the Spanish credit register to understand how monetary and economic shocks affect bank credit supply.

Theoretical papers suggest that negative economic shocks and contractive monetary policy not only reduce credit supply, but they do it more for ‘weaker’ banks (in terms of balance-sheet strength). The authors look at the probability that a loan application is granted depending on the capital and liquidity ratios of the banks when there is a monetary policy or an economic shock.

In the case of Spain, the credit register has better information than in most other countries because it contains not only the actual loans given, but also the loan applications. When a firm wants to borrow from a bank from which it is not borrowing yet, the bank fills in a loan application (with information on the firm and the quantity demanded) to obtain information regarding other loans of this firm.

As in each credit register, the data is a panel with three dimensions: bank, firm, and time. The variables of interest are bank-time-level (capital and liquidity ratios, which are proxies for the strength of a bank) and time-level (change in GDP and change in short-term rate). Moreover, the dependent variable is bank-firm-time varying. Hence, they can use firm fixed effects or even firm-time fixed effects; that is, they can control for any observed or unobserved time-varying heterogeneity across firms.

They find (Table 2) that increases in the interest rate are associated to a lower probability of granting a loan, and this association is stronger for banks with low capital and low liquidity ratios. Moreover, decreases in economic activity are also associated with lower probability of granting a loan, and this is stronger for banks with lower capital ratios.

They further control for firm-month and loan fixed effects (Table 3). This means that they look at each firm that applies for more than one loan in a given month, and see whether this loan is granted depending on bank capital and liquidity and their interaction with interest rate and monetary policy. Given that they use firm-month fixed effects, they can no longer identify the average effect of the shocks; instead, they can identify the importance of the bank variables as well as their interaction with the shocks. The results from Table 2 are mostly confirmed: increases in the policy rate are associated to a lower probability of granting a loan for weak banks as compared to strong banks, and negative economic shocks seem to have the same effect.

This paper provides the first and clearest evidence on the monetary policy transmission channel called ‘the bank lending channel‘, and in general on the importance of bank balance sheet strength for credit supply. In the next post I will talk about the second paper using the Spanish credit register, which looks at the ‘risk-taking channel‘ of monetary policy transmission.


– Jiménez, G., S. Ongena, J.-L. Peydró, and J. Saurina, 2012, “Credit Supply and Monetary Policy: Identifying the Bank Balance-Sheet Channel with Loan Applications,” American Economic Review 102(5): 2301-26.

About the theoretical papers, here there are some:

– Bernanke, B. S., and A. S. Blinder, 1988, “Credit, Money, and Aggregate Demand,” American Economic Review 78(2): 435-39.

– Bernanke, B. S., and M. Gertler, 1989, “Agency Costs, Net Worth, and Business Fluctuations,” American Economic Review 79(1): 14-31.

– Bernanke, B. S., and M. Gertler, 1995, “Inside the Black Box: The Credit Channel of Monetary Policy Transmission,” Journal of Economic Perspectives 9(4): 27-48.

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