Introduction to Banxico’s Findings
During periods of tight monetary policy, private banks tend to lend more to relatively safer businesses capable of paying higher interest rates, according to researchers at the Bank of Mexico (Banxico).
However, during these periods of interest rate tightening, financial institutions usually reduce their investments in riskier and long-term assets such as consumer and real estate loans.
The “Enigma of Bank Loans”
In some advanced and emerging economies, researchers have observed an unexpected phenomenon: increases in interest rates are accompanied by increases in bank lending. This paradox has been termed “the enigma of bank loans.”
Banxico’s researchers sought to analyze the impact of monetary policy on bank lending in Mexico from January 1986 to March 2016. Their findings suggest that the enigma of bank loans still exists at an aggregate level.
Short-term Impact of Lowering Interest Rates
According to Banxico’s research, a positive shock to interest rates (i.e., lower rates) leads to an increase in bank lending to businesses in the short term, which subsequently decreases. This effect is primarily observed in sectors with low average delinquency rates, such as manufacturing and finance.
The researchers found that different economic sectors may respond differently to monetary policy transmission through the credit channel.
It’s important to note that their estimations do not cover the period of the COVID-19 pandemic, and further research is needed to evaluate if the enigma of bank loans persists when considering this period.
The Role of Supply and Demand
Banxico’s researchers emphasize the importance of understanding supply and demand factors that might explain the “enigma of bank loans.”
They suggest investigating more deeply the roles of inventories or business expectations in increased bank lending during monetary tightening.
Key Questions and Answers
- What happens to bank lending during periods of tight monetary policy? Private banks tend to lend more to safer businesses capable of paying higher interest rates.
- What assets do banks reduce during periods of interest rate tightening? Banks usually decrease their investments in riskier and long-term assets, such as consumer and real estate loans.
- What is the “enigma of bank loans”? This paradox refers to the unexpected increase in bank lending when interest rates rise in some advanced and emerging economies.
- How do different sectors respond to monetary policy transmission through the credit channel? Different economic sectors may react differently, with some experiencing short-term increases in lending followed by decreases.
- What factors should be further investigated to understand the “enigma of bank loans”? Researchers suggest exploring the roles of inventories and business expectations in increased bank lending during monetary tightening.
