The Spillovers, Interactions, and (Un)Intended Consequences of Monetary and Regulatory Policies

Abstract

Have bank regulatory policies and unconventional monetary policies -and any possible interactions -been a factor behind the recent 'deglobalisation' in cross-border bank lending? To test this hypothesis, we use bank-level data from the United Kingdom -a country at the heart of the global financial system. Our results suggest that increases in microprudential capital requirements tend to reduce international bank lending and some forms of unconventional monetary policy can amplify this effect. Specifically, the United Kingdom's Funding for Lending Scheme (FLS) significantly amplified the effects of increased capital requirements on external lending. Quantitative easing may also have had an amplification effect, but these estimates are usually insignificant and smaller in magnitude. We find that this interaction between microprudential regulations and the FLS can explain roughly 30% of the contraction in aggregate UK cross-border bank lending between mid-2012 and end-2013, corresponding to around 10% of the contraction globally. This suggests that unconventional monetary policy designed to support domestic lending can have the unintended consequence of reducing foreign lending.

Gross Capital Flows, Common Factors, and the Global Financial Cycle

“…An alternative way to do this is by regressing the estimated factor loadings, which capture the impact of the factors on capital ‡ows, on suitable measures of countries'policy and structural features. 27 In principle, we could run cross-sectional regressions using as dependent variable the fullsample estimates of the loadings. However, these pertain to the full 37-year sample, a time span over which any candidate explanatory variables have surely undergone major changes, which would then obscure their relationship with the loadings in a pure cross-section.…”

The Shifting Drivers of Global Liquidity

“…Transmission of impulses through global banks to their affiliate locations internationally via internal capital markets follows a pecking order, with the degree of shock transmission to countries dependent on their bank-specific importance in lending and funding activity (Cetorelli and Goldberg, 2012b). Prudential policies and unconventional monetary policy in the form of a funding for lending scheme jointly contributed to a retrenchment of cross-border lending by UK banks (Forbes, Reinhardt and Wieladek, 2017). Consistent with these observations, some countries with banks that were well-capitalized pre-crisis, like Canada, expanded international activities post-crisis when foreign jurisdictions tightened capital requirements (Damar and Mordel, 2017).…”

International Credit Supply Shocks

“…Based on the insights from the theoretical model that we develop, we augment the PVAR model with the leverage of US Broker-Dealers, and then focus on a shock to this variable. While regulation and financial innovation determine it in the longer-term (Boz and Mendoza, 2014), over the business cycle several factors, such as monetary policy, the state of the cycle, and risk appetite can affect the leverage constraint (Rey, 2013, Forbes et al, 2016. We focus on the cyclical changes and do not take a stand on the ultimate cause of these shifts.…”