How capital inflows translate into new bank lending: tracing the mechanism in Latin America

Summary

Focus 

Capital inflows affect firms' access to bank lending in emerging market economies. For example, when local banks receive a cross-border loan or when they sell bonds to investors abroad, capital flows into the country that can be passed on to local borrowers. We look at how local lending standards change during periods of high capital inflows by exploring changes in outstanding loans and prices. We compare banks with different balance sheet characteristics and how their lending standards differ for firms with high borrower risk.

Contribution 

Five Latin American countries use their credit registry data to examine the changes in outstanding loans and prices that are charged by banks with different balance sheet characteristics: Brazil, Chile, Colombia, Mexico and Peru. Our meta-analysis sums up their results, comparing the impact of capital inflows on prices and quantities of bank lending across these economies.

Findings 

We show that during periods of high capital inflows, weak banks ease their lending standards. Compared with periods with low capital flows, these banks tend to lend more and charge a lower premium. Although there are differences at the country level, the effect on lending standards is broadly shared across different types of capital inflows and indicators for weak banks. For the most vulnerable market segment where weak banks lend to risky customers, we show that only banks with low capital ratios contribute to this easing. Financial stability concerns could arise, but they are limited as even low-capital banks have capital ratios above the regulatory minimum.

Abstract

We explore the mechanism that links capital inflows from abroad with domestic bank lending. Five Latin American countries use their credit registry data to examine the changes in outstanding loans and prices that are charged by banks with different balance sheet characteristics. Our meta-analysis sums up their results. We find that high capital inflows generally induce weak banks to relax their lending standards. For the most vulnerable market segment, where weak banks lend to risky firms, only banks with low capital ratios tend to lend more and charge less during periods of high capital inflows. Financial stability concerns could arise, but they are limited as even low-capital banks are above the regulatory minimum.

JEL classification: E0, F0, F1. 

Keywords: credit registry data, international capital flows, bank lending, SME financing.