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Capital controls, domestic macroprudential policy and the bank lending channel of monetary policy

Andrea Fabiani, Martha López (), Jose-Luis Peydro () and Paul E. Soto

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: We study how capital controls and domestic macroprudential policy tame credit supply booms, respectively targeting foreign and domestic bank debt. For identification, we exploit the simultaneous introduction of capital controls on foreign exchange (FX) debt inflows and an increase of reserve requirements on domestic bank deposits in Colombia during a strong credit boom, as well as credit registry and bank balance sheet data. Our results suggest that first, an increase in the local monetary policy rate, raising the interest rate spread with the United States, allows more FX-indebted banks to carry trade cheap FX funds with more expensive peso lending, especially toward riskier, opaque firms. Capital controls tax FX debt and break the carry trade. Second, the increase in reserve requirements on domestic deposits directly reduces credit supply, and more so for riskier, opaque firms, rather than enhances the transmission of monetary rates on credit supply. Importantly, different banks finance credit in the boom with either domestic or foreign (FX) financing. Hence, capital controls and domestic macroprudential policy complementarily mitigate the boom and the associated risk-taking through two distinct channels.

Keywords: Capital controls; macroprudential and monetary policy; carry trade; credit supply; risk-taking (search for similar items in EconPapers)
JEL-codes: E52 E58 F34 F38 G21 G28 (search for similar items in EconPapers)
Date: 2021-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-ifn, nep-mac, nep-mon and nep-opm
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Working Paper: Capital Controls, Domestic Macroprudential Policy and the Bank Lending Channel of Monetary Policy (2021) Downloads
Working Paper: Capital Controls, Domestic Macroprudential Policy and the Bank Lending Channel of Monetary Policy (2021) Downloads
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