A reformulation of the bank lending channel under multiple prudential regulations
Xiong Wanting Wang Yougui
Abstract: The Basel-III accord introduced multiple prudential regulations, sparking concerns that their simultaneous imposition may have unexpected effects on bank lending and its response to monetary shocks. This paper reformulates the bank lending channel (BLC) from a credit creation perspective and examines its changes under different prudential regulations. The traditional BLC predicts an increase in bank lending in response to expanding reserves. We find that such a relation only holds when liquidity requirements constrain banks. When capital requirements become binding and raising new capital is not an option, a reserve expansion may have no effect or may adversely impact bank lending. The simultaneous imposition of multiple regulations complicates the BLC by making it a nonlinear and non-monotonic process, with a strong dependence on bank-specific characteristics and the underlying economic condition. Prudential regulations may hinder the effectiveness of quantitative monetary operations, especially during financial distress.
Keywords: Bank lending channel; Basel III; Quantitative monetary policy; Credit creation; Bank regulation