A Prudential trade-off? Leakages and Interactions with Monetary Policy

21 Pages Posted: 6 May 2021 Last revised: 23 Jun 2021

Date Written: January 1, 2021

Abstract

While monetary and prudential policies are generally analysed separately, this paper focuses on how the two interact. Taking an international perspective, we show that monetary policy in a centre economy (Euro Area) spill over its borders through bank lending – therefore inducing volatility in cross-border lending flows. Investigating a sample of 30 advanced and emerging economies, we find evidence that prudential policy in the receiving-country interact with monetary policy so that a tighter prudential stance in the recipient-country mitigates the volatility of banking flows induced by monetary policy abroad. But we also show that a tighter prudential stance – interactions apart – implies a higher growth of cross-border lending. Taken together, these results might suggest a trade-off: while a tighter prudential stance reduces the volatility of cross-border lending flows, it also implies that local borrowers resort more to lending from abroad. Taking advantage of the granularity of our confidential dataset, we finally explore heterogeneities and show that such leakages arise only for financially more open economies and only through the financial sector, with evidence that such leakages are driven by intra-group lending.

Keywords: Monetary Policy, Prudential Policy, Policy Interactions, Spillovers, Prudential Leakages, International Banking

JEL Classification: E52; F34; F36; F42; G18; G21

Suggested Citation

Meunier, Baptiste and Pedrono, Justine, A Prudential trade-off? Leakages and Interactions with Monetary Policy (January 1, 2021). Banque de France Working Paper N°805, Available at SSRN: https://ssrn.com/abstract=3840224 or http://dx.doi.org/10.2139/ssrn.3840224

Baptiste Meunier (Contact Author)

Banque de France ( email )

Paris
France

Justine Pedrono

Banque de France ( email )

Paris
France

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