US monetary policy and fluctuations of international bank lending

Summary

Focus

What is the impact of U.S. monetary policy on cross-border bank lending? There is no consensus in the empirical literature. Some papers have found that the impact is negative, while others have found a positive relationship or mixed results.

Contribution

We use an innovative approach to reconcile the seemingly contradictory findings of the existing literature. We depart from it along two key dimensions. First, we identify two distinct regimes in international bank lending: a boom regime and a stagnation regime. Second, we decompose the federal funds rate into two distinct components: a macroeconomic fundamentals component and a monetary policy stance component.

Findings

We find that the impact of the U.S. federal funds rate on cross-border bank lending depends on the prevailing capital flow regime and on the level of the two main federal funds rate components. During booms, the relationship between the federal funds rate and cross-border bank lending is positive and mostly driven by the macroeconomic fundamentals component. This is consistent with search for yield by internationally-active banks. During stagnation episodes, the relationship between the federal funds rate and bank lending is negative, mainly due to the monetary policy stance component of the federal funds rate. The latter set of results is most pronounced for lending to emerging market economies, which is consistent with the international bank lending channel and flight-to-quality behavior of internationally-active banks.

Abstract

There is no consensus in the empirical literature on the direction in which U.S. monetary policy affects cross-border bank lending. We find robust evidence that the impact of the U.S. federal funds rate on cross-border bank lending in a given period depends on the prevailing international capital flows regime and on the level of the two main components of the federal funds rate: macroeconomic fundamentals and the monetary policy stance. During episodes in which bank lending from advanced to emerging economies is booming, the relationship between the federal funds rate and cross-border bank lending is positive and mostly driven by the macroeconomic fundamentals component, which is consistent with a search-for-yield behavior on the part of internationally-active banks. In contrast, during episodes of stagnant growth in bank lending from advanced to emerging economies, the relationship between the federal funds rate and bank lending is negative, mainly due to the monetary policy stance component of the federal funds rate. The latter set of results is most pronounced for lending to emerging markets, which is consistent with the international bank-lending channel and flight-to-quality behavior of internationally-active banks.

JEL classification: F21, F32, F34

Keywords: Monetary policy spillovers, capital flows, bank lending