Sovereign Risk and Cross-Country Heterogeneity in the Transmission of Monetary Policy to Bank Lending in the Euro Area

26 Pages Posted: 24 Sep 2018 Last revised: 19 Aug 2019

See all articles by Pietro Grandi

Pietro Grandi

Université Panthéon-Assas (Paris II) - Laboratoire d'économie mathématique et de microéconomie appliquée; Boston College

Date Written: September 6, 2018

Abstract

Is the transmission of monetary policy to bank lending heterogeneous across euro area countries? This paper employs annual bank level data to test whether the bank lending channel of monetary policy was heterogeneous in the euro area over the period 2007-2016. To do so it follows a simple procedure that allows direct testing of how monetary policy affected similar banks located in different countries. Results indicate that the transmission of monetary policy to bank lending was heterogeneous across countries that were differently exposed to the sovereign debt crisis. On average, the same 1% cut in the policy rate led to a 1.6% increase in lending by banks located in non-stressed countries as opposed to a 0.4% increase for banks located in countries under severe sovereign stress. Unconventional monetary policy – as captured by the ECB shadow rate – was also unevenly transmitted to bank lending. Exposure to sovereign risk is identified as a key source of heterogeneity. Within stressed countries, banks with larger sovereign exposures reacted to monetary easing by expanding lending by less than banks with smaller exposures. As a result, monetary accommodation was smoothly transmitted to lending only by banks with limited exposure to sovereign risk. In response to the same 1% policy rate cut, the credit expansion of highly exposed stressed countries banks was instead 2.75% weaker than that of banks in non-stressed countries. These findings support existing evidence on sovereign risk having direct adverse consequences for bank lending and highlight the extent to which sovereign risk aggravated heterogeneities in the transmission on monetary policy to the real economy via the banking system during the euro area debt crisis.

Keywords: Bank Lending Channel, Monetary Policy Transmission, Cross-Country Heterogeneity, Sovereign Risk, Financial Structures, Banking Integration

JEL Classification: E52, E58, F33

Suggested Citation

Grandi, Pietro, Sovereign Risk and Cross-Country Heterogeneity in the Transmission of Monetary Policy to Bank Lending in the Euro Area (September 6, 2018). European Economic Review, Volume 119, October 2019, Pages 251-273, Available at SSRN: https://ssrn.com/abstract=3245321 or http://dx.doi.org/10.2139/ssrn.3245321

Pietro Grandi (Contact Author)

Université Panthéon-Assas (Paris II) - Laboratoire d'économie mathématique et de microéconomie appliquée ( email )

4 rue Blaise Desgoffe
Paris, 75006
France

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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