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Bank asset quality and monetary policy pass-through

Robert Kelly and David Byrne ()

No 98, ESRB Working Paper Series from European Systemic Risk Board

Abstract: The funding mix of European firms is weighted heavily towards bank credit, which underscores the importance of efficient pass-through of monetary policy actions to lending rates faced by firms. Euro area pass-through has shifted from being relatively homogenous to being fragmented and incomplete since the financial crisis. Distressed loan books are a crisis hangover with direct implications for profitability, hampering banks ability to supply credit and lower loan pricing in response to reductions in the policy rate. This paper presents a parsimonious model to decompose the cost of lending and highlight the role of asset quality in diminishing pass-through. Using bank-level data over the period 2008-2014, we empirically test the implications of the model. We show that a one percentage point increase in the impairment ratio lowering short run pass-through by 3 percent. We find that banks with severely impaired balance sheets do not adjust their loan pricing in response to changes in the policy rate at all. We derive a measure of the hidden bad loan problem, the NPL gap, which we define as the excess of non-performing loans over impaired loans. We show that it played a significant role in the fragmentation of euro area pass-through post-crisis. JEL Classification: D43, E51, E52, E58, G21

Keywords: impaired loans; interest rates; monetary policy pass-through; non-performing loans (search for similar items in EconPapers)
Date: 2019-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkwps:201998

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