The effect of banking market structure on the lending channel: Evidence from emerging markets

• Date: 01 November 2013
• Author: Simon Wolfe,Mohammed Amidu
• DOI: http://doi.org/10.1016/j.rfe.2013.05.002
• Published date: 01 November 2013

The effect of banking market structure on the lending channel: Evidence

from emerging markets☆

Mohammed Amidu

a,

⁎, Simon Wolfe

b

a

University of Ghana Business School, P.O. Box LG 78, Legon, Accra, Ghana

b

Southampton Management School, University of Southampton, SO17 IBJ, UK

abstractarticle info

Article history:

Received 19 January 2012

Accepted 27 April 2013

Available online 13 May 2013

JEL classification:

E4

E5

F3

L1

Keywords:

Banking competition

Bank lending channel

Emerging markets

This paperanalyses the extent to which the level of bank competitioninfluences monetary policytransmission.

Using a largepanel dataset of 978 banks from55 countries, and employingthe Lerner index model as a measure

of marketstructure, our resultsshow that an increase in bankingsector competition weakensthe effectivenessof

monetarypolicy on bank lending.The findings are robust to a broad arrayof sensitivity checks includingcontrol

of alternativemeasurements of the Lerner index,different samples and differentmethodological specifications.

By extension, these results have important policy implications for regulators in assessing the effectiveness of

monetary policytransmission mechanisms.

© 2013 Elsevier Inc. All rights reserved.

1. Introduction

The objectiveof any economic policy accordingto Friedman (2008)

is to advance the economic well-being of a nation's citizens and to

strengthenthe institutions through whichthey interact to achieve this

welfare. Some of these institutions are financial intermediaries which

firms as well as households rely on to finance their projects. The key

objective of thispaper is to examine the role of bank market structure

in monetarypolicy transmissionas well as the effect ofmonetary policy

on bank lending.

1

The standard view of a transmission mechanism

focuses on the effectof monetary policy on interest rates andthrough

interest rates on lending and credit. According to this standard view

as explained through the interest rate channel, a changein the mone-

tary policy stance affects long-term interest rates and the exchange

rate, and this alters relative prices in the economy, the price of future

consumptionand investment relative to theprice of present consump-

tion, and the prices of foreign goodsin terms of domestic goods (Bean,

Larsen,& Nikolov, 2002).

2

In contrast,the bank lending channelof mon-

etary policy transmission focuses not only on the impact of monetary

policy on demand for loans, but more important on the supply of

loans. However,to support the existence of a lending channel, thereis

a need for evidence that monetary policy tightening causes a shift in

the supply of loans and that there are certain categories of borrowers

who depend onbank loans for their finances.

Studies on the bank lending channel, either country specificor

cross-country, have centred onidentifying its existence, ongauging its

potencyand its overall importance,on identifyingshifts in loan demand

fromshifts in loan supply, and on types and distributionaleffects.

3

Little

attention has been given to the effect of banking structure on the

response of banklending to monetary policy. The argumentin support

of the banking structure-lending channel hypothesis is that monetary

policy not onlyaffects bank reserves either throughopen market oper-

ations or reserve requirements, but also impacts on marginal cost

Review of Financial Economics 22 (2013) 146–157

☆The authors thank the editor and two anonymous referees for helpful comments.

The authors alone are responsible for any remaining deficiencies. Mohammed Amidu

would also like to thank the University of Ghana Business School for financial support.

⁎Correspondingauthor at: Universityof Ghana Business School,P.O. Box LG 78, Legon,

Accra,Ghana. Tel.: +233 244 232879; fax: +233 302 500024.

E-mail address: amidu@ug.edu.gh (M. Amidu).

1

Bankingmarket structure refers to thedifferent attributes of a market,including the

number and distribution of banks (Bauer & Cromwell,1989), specificcharacteristicsof

the banks within the market and the characteristics of the market itself (De Nicolo,

Bartholomew,Zaman,& Zephirim, 2004). Throughoutthis paper marketstructure or bank

marketstructureconnotes the competitivenessor non-competitiveenvironmentin which

the banksoperate.

2

The interest rate channel cannot fully explain the intensity, timing and composi-

tion of responses of real variables to variations in monetary policy (Pruteanu-Podpiera,

2007). Bernanke and Gertler (1995) provide an exposition of what the interest rate

channel theory fails to explain.

3

Since the seminal work of Bernanke and Blinder (1988), there have been several

papers on the bank lending channel through which the monetary policy transmission

mechanism operates (see Altunbas et al., 2002; Brissimis & Delis, 2009; Ehrmann et

al., 2003; Kashyap & Stein, 1995, 2000; Kishan & Opiela, 2000).

1058-3300/$ –see front matter © 2013 Elsevier Inc. All rights reserved.

http://dx.doi.org/10.1016/j.rfe.2013.05.002

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Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe