Capital Controls, Domestic Macroprudential Policy and the Bank Lending Channel of Monetary Policy

68 Pages Posted: 11 Aug 2021

See all articles by Andrea Fabiani

Andrea Fabiani

Bank of Italy

José-Luis Peydró

Imperial College London; Centre for Economic Policy Research (CEPR); Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Paul E. Soto

FDIC, Division of Insurance and Research

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Date Written: May 2021

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.

JEL Classification: E52; E58; F34; F38; G21; G28.

Suggested Citation

Fabiani, Andrea and Peydro, Jose-Luis and Soto, Paul E., Capital Controls, Domestic Macroprudential Policy and the Bank Lending Channel of Monetary Policy (May 2021). FDIC Center for Financial Research Paper No. 2021-06, Available at SSRN: https://ssrn.com/abstract=3902070 or http://dx.doi.org/10.2139/ssrn.3902070

Andrea Fabiani

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Jose-Luis Peydro

Imperial College London ( email )

South Kensington Campus
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London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

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Barcelona, Barcelona 08005
Spain
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HOME PAGE: http://https://sites.google.com/site/joseluispeydroswebpage/

Paul E. Soto (Contact Author)

FDIC, Division of Insurance and Research ( email )

550 17th Street NW
Washington, DC 20429
United States
202-898-6810 (Phone)

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