Is the Excess Capital Adequacy Ratio Beneficial in Neutralising Excessive Credit Growth and Inflationary Pressures? What Are the Implications for Monetary and Financial Policy?

Nombulelo Gumata () and Eliphas Ndou
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Nombulelo Gumata: South African Reserve Bank

Chapter Chapter 25 in Achieving Price, Financial and Macro-Economic Stability in South Africa, 2021, pp 381-393 from Springer

Abstract: Abstract What is the impact of the excess capital adequacy ratio (CAR) on excessive credit growth and inflationary pressures? Did excess CAR neutralise the repo rate adjustments? Evidence shows that excess CAR dampens the impact of demand shocks on credit growth and GDP growth in line with the intended primary purpose of countering the amplitude and duration of the financial and business cycles. But it is also true that excess CAR propagates and amplifies adverse demand shocks on credit growth and GDP growth as was the case post-2007. Excess CAR is detrimental to credit growth and GDP growth because it restricts the supply of credit during severe financial shocks and demand shocks. Furthermore, excess CAR becomes pro-cyclical during severe financial and business cycles downturns. Hence, in part credit growth and GDP growth remained subdued post-2008. In addition, excess CAR dampened the transmission of positive cost pull or push shocks to inflation especially post-2008Q1, thus sustaining muted inflationary pressures. Excess CAR propagates financial shocks via the financial accelerator mechanism, plays its intended role as a cushion for banks and prevents balance sheet damage due to severe financial shocks and adverse shocks to the business cycle. However, excess CAR accentuates the responses of credit growth and GDP growth to tight monetary policy shocks. This means that excess CAR is a potent propagator of tight monetary policy to credit growth and GDP growth. These two policy tools interact and reinforce each other’s effects in the same direction. Nonetheless, excess CAR is not a potent tool in neutralising other inflationary processes driven by factors such as the exchange rate passthrough to inflation. In this respect, other central bank balance sheet policy tools possess superior properties and are well positioned to complement the repo rate as a monetary policy tool.

Date: 2021
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DOI: 10.1007/978-3-030-66340-7_25

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