Is the Bank Lending Channel of Monetary Policy Evident in the Philippines? A Dynamic Panel Data Approach*

• Published date: 01 September 2021
• Author: Jean Christine A. Armas
• Date: 01 September 2021
• DOI: http://doi.org/10.1111/asej.12249

Is the Bank Lending Channel of Monetary Policy

Evident in the Philippines? A Dynamic Panel

Data Approach*

Jean Christine A. Armas

Received 5 June 2020; Accepted 20 July 2021

The paper examines the bank lending channel of the monetary transmission mecha-

nism in the Philippines. Using the dynamic panel generalized method of moments

(GMM) model on quarterly individual bank data from Q1:2006 to Q4:2017, the

study finds that the bank lending channel of monetary policy in the Philippines is

rather weak as highly liquid banks tend to react more to monetary tightening than

less liquid banks. More liquid banks would rather hold their stock of liquid assets

as buffers against crises than sustain or expand their lending activity amid monetary

tightening. Banks are also risk-sensitive in their lending behavior as the increase in

the cost of borrowing following tighter monetary policy could increase the likeli-

hood of loan default. The banks’cautious lending behavior supports the policy

stance of the Bangko Sentral ng Pilipinas in terms of prudent regulatory standards

to maintain the resilience of the Philippine financial system.

Keywords: bank lending channel, monetary policy transmission, dynamic

panel data.

JEL classification codes: C23, E52, G21.

doi: 10.1111/asej.12249

I. Introduction

The intrinsic information asymmetry problems present in the financial markets

and the role of commercial banks in responding to these issues make the credit

channel of special research interest (Mishkin, 1996). The two primary mecha-

nisms of the credit channel, as identified by Bernanke and Gertler (1995), are the

balance sheet channel (BSC) and the bank lending channel (BLC). As the former

highlights the importance of monetary policy changes to borrowers’financial

statements, the latter underscores the impact of monetary policy decisions to loan

*Armas (corresponding author): Bangko Sentral ng Pilipinas Complex, A. Mabini Street, Malate,

Manila, Philippines 1004. Email: armasja@bsp.gov.ph

© 2021 East Asian Economic Association and John Wiley & Sons Australia, Ltd.

Asian Economic Journal 2021, Vol.35 No. 3, 246–269 246

provision by deposit-taking ins titutions.

1

When a central bank tightens monetary

policy, bank deposits tend to decline, affecting banks’ability to fully compensate

for the shortage of deposits with alternative sources of funds. In this case, the

banks are prompted to reduce available loanable funds (Farinha and

Marques, 2001). This mechanism is referred to as the BLC of monetary policy.

The BLC of monetary policy allows central banks to affect the supply of credit

from banks and, consequently, influence the activities in the real economy

(Brissimis et al., 2001). The relationship between monetary policy and bank lending

is predicated on the basis of substitutability of the sources of credit. When a central

bank raises the policy rate, a decline in reservable liabilities (e.g. deposits) is not

fully offset by an increase in non-reservable liabilities (e.g. debt securities), leading

to a decline in bank liabilities. Banks cannot always reduce their investments in

securities to sustain their lending activity due to the risk associated with the invest-

ments. In this case, the loan portfolio of the banks is likely to decline. Kashyap and

Stein (2000) note that the existence of the BLC of monetary policy can be tested

based on three bank-specific characteristics: size, liquidity and capitalization. They

argue that the BLC of monetary policy hinges on the concept that banks with weak

balance sheets cannot tap uninsured sources of funds to make up for the shortfall in

their deposits following a contractionary monetary policy shock. In most developed

economies, where the financial system is highly developed, sourcing funds through

the capital markets is relatively easier. However, for countries with less developed

financial systems, borrowers like households and small and medium-sized enter-

prises have to rely on traditional bank lending for their funding requirements.

During periods of tight monetary policy, bank deposits fall and asymmetric

information problems encumber banks with weak balance sheets to insulate their

loan portfolio due to limited access to unconventional or non-deposit sources of

funds. The monetary transmission channel of the BLC in the Philippines is criti-

cal for managing the business cycle effects and the economic shocks in the

economy. In an emerging market like the Philippines, raising or sourcing funds

in capital markets is challenging. The Philippine financial system is largely dom-

inated by banks, covering 82 percent of the financial system ’s total resources.

2

Moreover, the Philippine banking system is the domestic economy’s primary

source of credit to the formal economic sectors in the country, accounting for

59 percent of GDP as of December 2019.

3

The banking system in the

Philippines follows the generally stringent and prudent lending regulations of

the Bangko Sentral ng Pilipinas (BSP). Hence, it is important to understand and

1

The terms ‘loan’and ‘credit’are used interchangeably in this paper. Deposit-taking institutions,

in this paper, are, likewise, referred to as the banking system (e.g. universal, commercial and thrift

banks).

2

Data is as of June 2020. Source: Department of Economic Statistics, Bangko Sentral ng Pilipinas

(BSP).

3

Bank credit to GDP is computed as the ratio of the gross total loan portfolio of the banking sys-

tem to annualized GDP. Data source: Bangko Sentral ng Pilipinas (BSP) and Philippine Statistics

Authority (PSA).

A DYNAMIC PANEL DATA APPROACH 247